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Bond yields remain low despite previous expectations that they would rise this year. Stocks have been largely resilient despite economic weakness. Clearly, the global recovery isn’t following a set script. As investors look for cues to their next move, where are the hidden risks and the unseen opportunities? Find out what our panel of economic, equity and fixed income experts think.
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00:54:10
Recorded Date:
7 October 2014
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Invesco Transcript
SFID 33596 54.09 33596 Invesco Interactive Sept 2014_v1
CONFERENCE CALL PARTICIPANTS
Tom Keene
Bloomberg News – Editor-at-Large
Greg McGreevey
Invesco – Head of Invesco Fixed Income
Ron Sloan
Invesco Global Core Equities – Chief Investment Officer
John Greenwood
Invesco Ltd – Chief Economist
PRESENTATION
Tom Keene
Hello and welcome to Invesco Interactive, I am Tom Keene of Bloomberg News, with me today are John Greenwood, Chief Economist for Invesco, Greg McGreevey is Head of Invesco Fixed Income, and Ron Sloan with us today, Chief Investment Officer of Invesco Global Core Equities. Our panelists are here to discuss the global recovery; well, it’s not exactly following a set script and what it means for all investors worldwide. I will get our conversation rolling, but it’s important that we hear from you. You can submit questions for our panel online. We will add them into our conversation as time allows. We also have a few questions for you as well, which you will be able to answer through your video player later in the conversation.
Let’s get started and, gentlemen, it’s such joy to do this. I get feedback from being with Invesco. I always walk out of here learning something. I hope I get to learn something about the unscripted economy. Greg, I am going to pick on you to start, thank you for the script of higher interest rates. That worked out. Why did everyone, and I mean even the people looking for low interest rates – Gary Shilling always looking for a 1% 30-year bond – everybody got this call wrong. Why was that in hindsight?
Greg McGreevey
To, Tom, I want to just correct you a little bit, because I think we've been in the camp that interest rates weren't going to go up for quite some time and I think we still are in that camp, especially on the long end.
Tom Keene
The framework of where we are now is pretty even.
Greg McGreevey
Yes, so I think the framework is a really simple one, at least as we see it, against the backdrop of complicated markets overall. One, interest rates on the long end of the curve really coincide with long-term potential GDP, which we think is around 2% and that’s about what we've averaged in the US on a real GDP basis over the last 10 years. Now, clearly, there is a little bit greater growth that we expect in the short run. We think that’s more cyclical and that combination with job growth and the unemployment rate beginning to decline is going to put a little bit of pressure on the Fed to begin to raise interest rates sometime in the end of the second quarter/beginning of the third quarter next year. What we think is going to happen is that as the Fed begins to move, and we think when they do they will be measured, the short end of the curve will go up a little bit. We don’t think that long rates, because what I said about long-term potential for GDP isn't really going to go up that much.
Tom Keene
Does that curve flattening that we see, the 2-year comes up and the 10-year doesn’t move all that much, that curve flattening, does that signal recession?
Greg McGreevey
It doesn’t signal recession for some time and the reason it won't because the curve will still be relatively steep by historical standards, but I think you're absolutely right. The curve, we think, is going to flatten; with 2-year and short rates going up, the 10-year really not moving that much, it might go up a little bit, but it really is going to take that curve to be flat between 2s and 10s for us to really be concerned about some recessionary pressures down the line.
Tom Keene
Ron, in your world, the unscripted idea that I see is we’re correction-free, is just up, up, and up, up, up, up, up. The media – I'm as guilty of this as anyone – “Oh, we’re down 4%, oh no! Go to cash!” and this is the new pressure, is people can't withstand a loss anymore, that’s part of the new script.
Ron Sloan
Well, I think it is, because everyone took such a shellacking in the Great Recession, but the Fed’s got our back, right? If you're an equity money manager right now, almost bad news is still good news. We have got to get beyond that for things to really change much. We have got to make bad news bad news and good news good news, and how does that occur? Well, it’s some of what Greg’s talking about, but even today, when we get the bad news and then we have the one or two-day knee-jerk bounce, because, oh, the Fed’s got my back, the utility of that trade is getting shorter and shorter and shorter, so I think, my God, you know, Ms Yellen needs to let go of the microphone. She needs to allow rates to move up a little bit.
Tom Keene
You think there is too much information.
Ron Sloan
There is too much information and what we need is businesses to stop waiting for it to occur. Let it – it could happen tomorrow.
Tom Keene
What would happen – to you and the equity markets, what would happen if there was a modest rate increase?
Ron Sloan
People would embrace it.
Tom Keene
There would be a 6-hour boost in Bloomberg ratings, thank you Ms Yellen, and then we would move on, right?
Ron Sloan
I think so. If we’re going to transition from a valuation economy to an earnings economy – and that was the story at the beginning of the year, you know – we have got to get the rate issue and the ‘Fed’s got my back’ issue out of the way.
Tom Keene
Part of our unscripted sense, and you’ve been I'm going to call it measured and cautious bull versus the effervescence, is you call valuation stretched right now. Justify that statement.
Ron Sloan
Well, what we have seen is we have seen company CEOs quickly get in the embryonic position; when anything happens, they don’t seem to be able to grow their top line, so darn, we’re not going to spend a nickel. The market is not going to reward us for spending any money; in fact, the markets are going to reward us…
Tom Keene
You don’t see investment yet across all the companies as investors.
Ron Sloan
We do not, although this year we have seen some evidence that capital spending intentions are rising and are being sustained, but it’s small numbers at this point in time.
Tom Keene
John, I had to open up with Greg and Ron, because you and I could spend not only an hour, you and I can go for like eight hours, we can go for the length of the Ryder Cup, and talk about this most unusual era. I am reading Henry Kissinger’s World Order right now. It’s extraordinary. The span of history, you could compress it all into 2014. This has truly been unscripted in geopolitics and in global economics, hasn’t it?
John Greenwood
It certainly has. Both the turmoil in the Middle East, the conflicts in Ukraine, the big changes that we’re starting to see in Russia, the slowdowns in India and Brazil, I mean in economic terms these are all big events.
Tom Keene
Are they big events that signify a global slowdown with IMF meetings coming up in October? The OEC came down, the IMF no doubt will ratchet in their expectations. Does that lead to not a global recession, but just dampened growth?
John Greenwood
No, I think that the fundamental drivers of the business cycle are the kinds of things that Greg was talking about earlier. That is it’s rates of growth of money and credit, the shape of the yield curve, and particularly the level of short-term real rates. Now, those are not going to be affected by those geopolitical events. You can get short-term disruptions, but they're not going to terminate the business cycle for the US or for the UK. Europe is a bit more vulnerable to what happens in Ukraine and Russia.
Tom Keene
And part of your Invesco literature, which I know is at your website, is this de-linkage of Europe with America, which many other people have talked about. How big is the de-linkage of this Fed policy in John’s world, how does that come over into the fixed income market?
Greg McGreevey
Well, I think it’s directly, related, Tom. I mean I think what we’re seeing right now is divergence I think between a lot of different economies and Central Bank policy, especially between Europe, which has to grow its balance sheet to kind of deal with some disinflationary pressures that are bordering on deflation in the Fed, which right now is looking at the possibility of raising rates, so we haven't seen that over the last five years. It’s been Central Bank coordination. Every time there has been some challenge, Central Banks have come in by and large to provide support overall to the system, so we think that has implications overall for a variety of different asset classes that we can get into in this discussion. I think the one area, just tying back to one of the things John said, I think we probably are a little bit more sanguine on global growth. In part because of some of the structural and cyclical issues that are impacting many economies overall; Asian demographics that exist in almost all markets and some cyclical factors that a lot of these countries still have too much leverage. That deleveraging creates some challenges for growth overall.
Tom Keene
Within the challenges that we learned as to the taper tantrum in which you waged in that August a few years ago is just recently high yield has given it up. Are we doing fixed income in an unscripted environment for the coupon when we forget about total return?
Greg McGreevey
Well, I think we probably…as we look at the market, just given how much valuations have moved over the last number of years, and we said but what's your forecast for fixed income, we would say it’s largely coupon-driven and that’s an environment that just tells you that valuations are falling. It doesn’t mean you can't get good returns or good income. It just tells you that you don’t have that much in price appreciate.
Tom Keene
And, Ron, actually Bob Huber, our expert in Bloomberg LP, helped me today with the Bloomberg terminal about dividend and share buyback algorithms. I mean that’s essentially the new total return, is dividend growth along with share [repurchase] along with debt reduction. Does that continue?
Ron Sloan
Until we see a final demand improved market, yes it is unfortunately, because I think that playbook is getting tattered, is getting warn out, it’s been used so much in recent years, so nominal GDP growth. We know…I believe, I think, and John may disagree, but I think the Fed has been targeting nominal GDP growth and they're unhappy and their frustration is that it’s not higher, and they will pay a price to get that number higher and that’s what will stimulate a lot of things that are going to come.
Tom Keene
Well, I was going to go holy Greg Mankiw on that earlier. Are we targeting nominal GDP? Can get in a fistfight here?
John Greenwood
No, that’s not fair, but the fact is that we live in a world where money and credit are created through the private sector and it’s the risk aversion in the private sector, households and financial institutions, that have been reluctant to create that credit and the corporate reaction that Ron is talking about, their reluctance to invest, follows from that. The corporate CEOs and the CFOs know that the consumers are not going to be going to shopping mall and spending as much as they would in a normal recovery, so they're holding back from building those shopping malls, creating those distribution centers.
Tom Keene
Yes, but the heart of this, John, is just we had our second quarter create a bounce off the frozen tundra of the first quarter; a 4% plus GDP, throw in some inflation, it’s a 6% nominal GDP. Ron should be the happiest guy in the room. That’s a terrific animal spirit. Can that be sustained?
John Greenwood
I doubt it. I think it’s kind of a temporary blip.
Tom Keene
A one-off.
John Greenwood
I think growth is gradually improving. I mean it’s not going to skyrocket to the 4s on a sustained basis. I think more likely we will drop back into the 3s and we may average even less than that on a longer-term.
Tom Keene
Yes, I get the sense, Ron, you're more cautious of that.
Ron Sloan
Slightly, slightly more. What I think we can sustain though, Tom, is that throughout the summer we have seen pretty good manufacturing numbers and to the degree that we had a 4% second quarter, we got some bounce-back, but we are in that bottoming process of improving manufacturing numbers. This is going to be from here an investment-led recovery – from here.
Greg McGreevey
But, Tom, maybe I just want to add one thing, if I can, so I think the thing that we have to just think about from a gross standpoint overall and sometimes because of weather-related impacts of the first quarter, you know, there was some pent up demand and some issues that happened in the second quarter, but every time we have forecast that the US economy was going to get back on track…
[All talking]
…it hasn’t done it and part of that is these structural issues that come into play, but usually after a significant crisis like we enjoyed or happened to go through in 2008, what do we know from those things historically? Cycles last a lot longer and typically it curtails growth for a whole bunch of different reasons and I think the way that this market is playing out is exactly how it historically plays out, number one, and then you have these structural factors that really started before the crisis in terms of our growth. You have to go back to get 3 or 4% real GDP growth in this country into 2003/2004.
Tom Keene
To move on in our unscripted environment, part of the unscripted sense is better than good equity markets and emerging markets. A question from our audience, “How do you approach emerging market bonds in the fixed income markets abroad in this market?” Greg, within the amazing geopolitics and minute-by-minute tick of where we are, somebody still has to invest abroad in these bonds. Are they an intelligent place to be now? Do you get that better coupon?
Greg McGreevey
Well, I think it depends and…
Tom Keene
What's a Philippine coupon? I don’t know – 7%?
Greg McGreevey
Yes, it’s about that.
Tom Keene
It looks great.
Greg McGreevey
Well, it looks great, but I think the headline story I think on EM is it’s a very idiosyncratic story, so not all EM bonds are created equal, so I think if you wanted to just provide the headline, I think that’s it. Now, if you just said there are three sectors in the EM market, EM corporate which is corporations in EM, EM local currency and then EM sovereigns, so the sovereigns of these Governments that are out there, I think as we look at the EM market overall, we’re probably most positive on the corporates, corporations that do business outside of certain geographies in general. We’re least positive on EM local currency and that’s been where we probably have been underweight a significant amount of…
Tom Keene
Because you’ve got Dollar strength…
Greg McGreevey
Because of the Dollar strength and typically especially those that need Dollar financing, we know how that market usually plays. These countries usually are impacted from a pricing standpoint.
Tom Keene
John, before any of you stop the show here, let’s talk on currency markets. Right now, Sterling went to a 1.60, Scottish votes and dynamics there. The UK economy I felt in your research note you have a pretty constructive view on. Is part of that the No vote in Scotland?
John Greenwood
Well, there was a relief bounce after the No vote, but more fundamentally, the UK is enjoying a pretty solid recovery now. It’s lagging behind the US recovery, but it’s following the same track. Now, that’s in contrast with what's happening in Continental Europe where the ECB has not done enough to stimulate growth. It hasn’t done the kind of QE that we had from the Fed or the QE that we had from the Bank of England, so basically we have got this divergence. We have got the UK and the US together recovering, and both of those likely to raise interest rates over the next year, whereas in Europe, we know that interest rates on Draghi’s forward guidance are going to remain where they are for the next four years.
Tom Keene
Well, let me ask you a direct question, and this of course goes with your storied career in economics, I spoke to Paul De Grauwe last week at the London School of Economics, who seriously questioned how the European Union can sustain a weaker Euro along with their banking system. Do you have a grave enough concern about deflation in Europe and the unscripted stories of Europe?
Were you concerned about 1.20 Euro or 1.15 Euro and the instabilities that that could bring?
John Greenwood
A weaker Euro will help the European economies. That’s not a problem for them. I mean their problem was while the Euro was so strong, the economies couldn’t grow their exports and, therefore, there was no path out. Now, the promises of a greater expansion of the ECB’s balance sheet, purchases of ABS and covered bonds, and these are just promises at the moment, that’s helped to weaken the Euro and that will help some of the economies to increase their exports, but without not just an expansion of the ECB’s balance sheet, but importantly, an expansion of the deposits and loans of the commercial banks…
Tom Keene
The pulse of the banking system.
John Greenwood
Yes, the transmission mechanism, we won't get a recovery, so…and the same is true in Japan. In Japan, what we are seeing is a huge expansion of the balance sheet of the Bank of Japan, but it’s not transmitting to the commercial banks.
Tom Keene
What Yen do you need to get Abenomics to click in with a vengeance – 1.20?
John Greenwood
Again, the key is not the Yen itself. A weaker Yen…
Tom Keene
But that’s convenient for television and radio.
John Greenwood
Sure, but a lower Yen will help, but the key is stronger domestic demand and you won't get that either in Europe or in Japan until you get that transmission mechanism working and that in turn is related to the state of balance sheets.
Greg McGreevey
Maybe just a couple of comments on currency as it relates to the Yen. I think the real issue for Abenomics to work is the structural issue. They don’t have…their aging population is the oldest in the world, they have a number of people who have come out of the workforce, so the two legs of the three-legged stool they’ve already been able to accomplish. They have had fiscal reform. They have been able to weaken their currency to help their exports. The structural issue is the biggest issue and if they can solve that, and I think we’re skeptical about them doing it, then that’s really going to have indications not only for the Yen, but the ability for them to grow.
Tom Keene
I want to digress here to Hong Kong, but first, over to our first poll question of this session in an unscripted recovery. Here is the question: “What global region are you most bullish on for the coming years: the Unites States, Europe, Japan, and of course, Asia ex Japan?” I think that’s an important question. What area are you most bullish on for the year? Let’s get your answers here as we go through the session.
John, with your storied career in Hong Kong and you were there, of course, for the changeover, what we have witnessed in China, in general, and Hong Kong just in the last days and weeks is truly extraordinary. Can Beijing manage Hong Kong forward in a manner that leads to stability for Hong Kong, for China, and for that matter, all of Asia?
John Greenwood
Hard to say. The demonstrations that we have seen in Hong Kong have so far been very largely peaceful and they reflect this frustration that China is going to be picking the candidates among whom Hong Kong people must choose for their next leader, and that’s kind of a sham democracy in the view of Hong Kong people. Now, a critical thing is this: if the demonstrations continue, and they're peaceful and passive, for let’s say a month then I think there is a heightening risk of intervention from Beijing. For the moment, I don’t think there is any risk of that at all, so provided that the demos kind of fade way then there shouldn’t be too much problem, but the problem is that the demonstrations were the Occupy Central Movement, as it was called, was led by a bunch of 60year-olds, Anson Chan, Jimmy Lai, Martin Lee, people like that…
Tom Keene
I spoke to Martin Lee today actually.
John Greenwood
…and recently what's happened is that those guys have lost control of the leadership and it’s now in the hands of students…
Tom Keene
Well, give us perspective then on that generational change. That was my next question. We see whether it’s Ukraine or the Middle East, or these other unscripted moments, part of it is a generational change, isn't it?
John Greenwood
It is. I would hope that China has the maturity to kind of allow Hong Kong to make its own choice, but frankly, I think that’s very unlikely, so much will depend on how long this goes on for. If it’s like the protests on the Lehman mini-bonds, they went on for five or six years, but there were small numbers of people. Those were the bonds that had been sold that were wiped out during the 2008/9 crisis, but if larger numbers of people continue to protest then there is a risk that some…the economy would be affected and then I think that intervention might…
Tom Keene
And to bring this back to my 401K, Ron, we’re living with the speed of media and the images of John’s economics, and yet we have got to stay 100% – you told me you're going to be 100% invested. I am in a double-leveraged all-cash fund; it’s great, 200% cash and I make enough, but the bottom line is these unscripted events shake our confidence in your equity markets.
Ron Sloan
It may shake the confidence, but obviously the market is saying don’t worry, the Fed’s got our back and that goes back to this whole issue, and I think we’re losing some of that, so to John’s point, when does social media cease to become a social positive and become a social negative? If it’s truly the 17 and 18-year-old who are leading this charge in Hong Kong, as they did in the Middle East and more than likely how they did in the Ukraine, the hallmark of a young person is impatience. They don’t have the perspective to take a long-term view and so these things will bubble up quicker rather than later, so your answer is, okay, yes, we have some cash in our funds, because we are more cautious, we are more conservative. There is an old saying in the stock market, you can't buy bargains with bargains, so the thing you don’t want to have to be is a seller in any sort of pullback in the marketplace to buy something else. You want to have thought through that beforehand.
Greg McGreevey
But, Tom, these things have come up since the beginning of time that there are going to be situations…
Tom Keene
These unscripted events.
Greg McGreevey
…and so, yes, there are more of them today, but the reality is unless it creates a supplier/demand side shock, which we could argue about Ukraine, potentially in Europe, and maybe the Middle East, unless those things happen, the market usually digests them pretty quickly and gets back to fundamentals of the market and valuations, and how they feel about it, so again, there are some things that we have to watch closely, but this is nothing new. It’s just the magnitude of which, and the number I guess, of the events we’re seeing right now.
Tom Keene
I want to go back to our unscripted, our recover, in the Unites States, but first, here are our poll results, which speak to the Unites States. On the most bullish region, and no surprise, agreeing with our panel members, the US 60% and Europe 25%; the idea that Europe would come along. Of course, that makes up 85% of the total pie and I think that’s a resounding result for it. John, let me ask you again about your relative optimism in the United Kingdom and on the Unites States. Does that just separate out Europe with deflation and this dreaded D word, this…we’re not used to this unscripted event of deflation. Will Europe see that?
John Greenwood
I think there is a significant risk of that. My forecast was for deflation going back 18 months ago. Basically, if you take broad money and credit, the size of the ECB’s balance sheet, which shrunk over the last year, I mean these things are not structured to create a recovery, so I don’t see the basis for a recovery. If you look at the ECB’s forecasts, of course this is propaganda, they're saying we’re going to have a recovery, inflation is going to pick up, but I don’t see…
Tom Keene
We don’t see it.
John Greenwood
I don’t see the basis for that. I think growth…well, the economy is kind of bumping along the bottom and it’s going to take a lot more intervention of the kind that we saw by the Fed and the Bank of England to turn things around.
Greg McGreevey
Yes, Tom, we very much agree with that as well. I mean I think the one thing that we have to be cautious of is the difference between deflation, which is really all asset prices going down, and disinflation, which is just a drop in the inflation rate overall. They are very different events right now, but we think that Europe has to get action from the ECB. I think the ECB understands the challenge and the problem. There is obviously a lot of politics involved with their ability to implement, but they're just coming out recently with the expansion of their balance sheet. We think that’s going to continue and it needs to continue.
Tom Keene
Let’s bring it back to the Unites States right now and, Ron, I will talk to you; the unscripted word for 2014 is slack. I sat at the Economic Club of New York speech of Janet Yellen and I didn’t count, but I think I heard the word slack 42 times, something, maybe it was 43 times, but we have slack in the economy. As always, Invesco, terrific notes – I can't say enough, folks, about the quality of the Invesco literature and particularly the charts. This from Shigeru Fujita of the Federal Reserve Bank of Philadelphia, which absolutely destroys the cyclical, the up and down of the economy, being part of our persistent unemployment and that this is structural unemployment. In your world of equities, is this just corporations, they don’t need as many people as they used to?
Ron Sloan
They sure don’t, they sure don’t. I mean we can have a robust capital-spending environment and we’re having it right now in some ways. If we to just look at the middle of the country, kind of between the Appalachians and the Rockies, that’s really the most buoyant economic part of the Unites States.
[All talking]
Tom Keene
…understand that here, the middle of the country, is between 5th and 8th…
[Laughter]
Ron Sloan
But the classic New Yorker cover, right, you know, once you get past west of the Hudson, you're golden until you get to the Rockies and so that’s where job wanted postings are; it’s in middle America, it’s manufacturing. The auto companies are back. It’s obviously shale drilling all over in there, BMW spending $1 billion in South Carolina, Mercedes Benz…
Tom Keene
Where are the investment opportunities today?
Ron Sloan
But the people that are going to man this are not coming back, because they don’t need them. The scale of robotics, the scale of industrial automation.
Tom Keene
Just general productivity and capital…yes.
Ron Sloan
Because it has been so long, it has been a generation since we have needed those kinds of…
Tom Keene
I want to give this to Greg, but this important, where are the investment opportunities if we’re a peopleless business economy.
Ron Sloan
Well, we’re going to have to kind of rethink and reset expectations. The UAW wage settlement, when we were saving General Motors, what was the guts of that.
Tom Keene
Lower wages.
Ron Sloan
All the new hires, basically, half, so it is an A-class and B-class worker side by side on assembly lines…
Tom Keene
And you run that out 10 or 15 years and that is your new productivity.
Ron Sloan
That is the new story and so American Airlines, 30 years ago, A-class pilots, B-class pilots, today, you get in an American airlines plane, you don’t know what class pilots you have got, they're all Bscale pilots is the bottom line and that will be the industrial floor along with robotics.
Tom Keene
Greg, please.
Greg McGreevey
Well, we have added a lot of jobs in the economy, so to say that we’re not adding workers to our workforce I think would not really reflect what is going on in the situation. I think with the labor force, what really is going on is we have people who are retiring, because they are getting older and we have got that ageing demographic issue that hits almost all developed economies and some emerging market economies, but at the same time, we have people on disability and we have people who, post the Great Financial Crisis, have been out of work for a long time, they are underemployed, and they go into the unemployed category, so those workers are the potential workers that can come back into our economy, but those first two categories, which I think has been underestimated…
Tom Keene
Retirement and disability.
Greg McGreevey
Retirement and disability, those individuals are not going to come back into the workforce, and that is probably the biggest drop in what we have seen…
Tom Keene
You're seeing the Federal Reserve as a research body and as a responsible set of Presidents, Governors and Chair shift from a cyclical, ‘Don’t worry it will get better,’ over to a much more unscripted structural…
Greg McGreevey
Without question, Tom, and I think that has been a real surprise to us, because we did a lot of work on the labor force.
Tom Keene
Usually, when they say that at investment houses folks, that means they were wrong.
[Laughter]
Greg McGreevey
We have got a lot of respect for the Fed, they have a tough job, but we looked at the labor force dynamics, about a year and a half ago we did some research papers on it, and so we really don’t think the labor forces participation rate is going to come back. This is structural issue, not cyclical and it was only recently coming out of Jackson Hole when they really acknowledged that that was indeed the case.
Tom Keene
Here are the equities and the bonds, and what it sounds to me like, John, is Clement Attlee, England, where we’re rationalizing wage deflation. I am stealing here from Daniel Yergin and his fabulous book, Commanding Heights. Are we going back to what our grandparents knew, where, oh, a 2% raise, great, wage inflation is 2.4% and there is a chronic sense to that for too many in America.
John Greenwood
I think we are going to have sustained low inflation and that will mean that nominal wage growth will be pretty low. One way to characterize what is happening in the labor force and with the growth of jobs is this word they use, ‘Polarization.’ The jobs that are being created are mainly lower skilled or part time, that has been the majority of the job creation, and there are those in higher skill jobs who have managed to hang onto their jobs, so there is kind of the top end of the labor force and the bottom end. Those in the middle, they're sort of mid-skilled that used to make up the bulk of the economy, that is kind of thinning out and we’re seeing this polarization to the two extremes and that is true, not only in the US but also in the UK and Europe as well.
Tom Keene
Does the fixed income market underestimate this polarization, this two bell-curved world of the haves and the have-nots and how the Central Bank has to deal with that, and because it is two bell curves, not one combined bell curve, will we see a shock to our bond markets leading to instability and ultimately higher yields and lower bill, bond, and note prices.
Greg McGreevey
Well, look, it is a very complex question that you're kind of asking, Tom.
Tom Keene
We should go for another two hours, keep going.
Greg McGreevey
I think we can. I think that the fixed income in general probably isn’t underestimated, and I think when you look at data, just to get a couple of facts to a point that I very much agree with, with John, if you just divided up overall wage force, our worker population into deciles, 70% of our workforce outside of the top 30% really are worse off today when you look at wages as a percentage…
Tom Keene
Yes, irrefutable.
Greg McGreevey
It is irrefutable and so the top 30% are really, what is driving the economy. I think that is pretty known. I think fixed income managers who spend a lot of time looking at economic formation will look at wages and income as key drivers of what is going to happen to consumption, so I think they get that. The issue is going to be, is that going to change moving forward? Are we going to get some wages that allow income to go up, and I think that is a story that is going to vary depending on who is looking at the information and who is looking at the data overall.
Tom Keene
Within this economic and these unscripted moments that we have had, I believe you still read annual reports and quarterly reports. Do they have any value in the equity market? How do you read them differently now, given all this mumbo jumbo in John’s world?
Ron Sloan
Job number one, figure out asset allocation policy of corporate managements.
Tom Keene
Capital allocation.
Ron Sloan
Capital allocation, are we buying back shares, are we increasing dividends, what are we doing with our CapEx program? What are we doing with M&A? M&A and CapEx are married at the hip and so M&A is a kinder word and a corporate word for private equity, so all these things will probably come back at us as separate companies in 20 years, but for right now, we’re consolidating every industry. If we are truly in a disinflationary and inflation is not going to be a problem longer term, the companies that win in that environment are the companies that can bundle services and products, because good enough is good enough, and so they will be the ones to maximize margins in that environment, so those are the things that you're looking at when you're looking at capital allocation decisions by companies. Are they getting the proper returns and if they're not, in the short run, are they setting the table for a run in a couple of years.
Tom Keene
Is the unscripted bout of M&A, granted a lot of people predicted it, but the unscripted M&A that we’re seeing, is it nothing more than a revenue line grab, I can’t make revenue, I have got to go out and acquire revenue.
Ron Sloan
To some degree, but I think good companies…then it becomes a question of horizontal or vertical and if it a vertical M&A activity/acquisition, I think we can deliberately suppress margins in the short run to set the table for a lot of good margin growth in the long run, because the thing we can’t assure ourselves of is that we’re going to have the top line growth.
Greg McGreevey
I think the good thing about M&A activity today is, it is not financially motivated and driven, which in the true sense of the word, was say back in 2006 or 2007, these are more strategic acquisitions that are being made, they are more driven for top line revenue growth, because we know that revenue growth has typically not been there, so I think what we’re looking at, both from a fixed income standpoint and just risk assets overall, is when that story starts to change that were being driven by non-strategic reasons, financially motivated transactions that are at their core that maybe don’t make as much sense strategically and that is a market environment that we would be much more concerned about. We just really haven’t seen, either by number or by size those types of transactions being done.
Ron Sloan
I think that would be a horizontal acquisition more than a vertical acquisition.
Tom Keene
John, I mentioned the taper tantrum earlier and I can’t keep track of which emerging market is up or down, but I am still thunderstruck and I guess it goes back to the World Cup, the unscripted Brazil collapse and they have this election coming up, but I still can’t frame in my head Brazil with 3% GDP.
John Greenwood
It is less than that.
Tom Keene
It is less than that, but I can’t even get there. Can you frame that…?
John Greenwood
Let me try to give you a little perspective.
Tom Keene
Please.
John Greenwood
A year ago we were talking about the Fragile Five and the main problem with those economies, that was in reaction to the taper tantrum, the ones that suffered most were known as the Fragile Five, but actually they had made as many mistakes as – sort of imported mistakes – that they have over expanded, and as a result, they were vulnerable, they had current account deficits, they had rapid growth in money and credit, they had rising inflation rates. Now, all those countries in the aftermath of that, Brazil, Indonesia, India, Turkey, they all raised interest rates, which is the source of that slow growth today for those countries, why they're struggling. The other thing that has happened is that global trade has been virtually stalled for the last three years. If you take global trade in Dollar terms, because the US has been growing at subpar rates, Europe has been in stagnation, Chinese growth has been slowing, Brazil and India are slowing too, because of all of that, global trade has not grown at all. Now, most of those emerging markets were export driven and because that export driver isn’t there anymore, China had 29% per annum growth of exports between 2003 and 2008 in the bubble years. Today, the growth rate is in low single digits.
Not only did these counties have to curtail the exuberance that they had initially come out of the recession with, but in addition, they have had this headwind of slowing global trade, and both of those two things have hurt the emerging world. They are going to have to wait for a global pickup, and particularly a pickup in the US and other developed countries, I think, before we can also see a recovery in those countries.
Tom Keene
Let's summarize some of these concerns within an unscripted recovery, and of course the Dow and the S&P near record highs, and interest rates to all considered actually very low, and one of the great calls here for Invesco has been calling for subdued rates. You look at some of the concerns that are out there, one of them is Central Bank policies, that is part of our poll. Is it Central Bank policies? Is it various concerns in the Middle East, Ukraine, and of course what we have seen in Hong Kong and elsewhere? Is it continued weakness in Europe? I think that is underestimated when I see day to day, or is it Chinese economic weakness? The Chinese collapse that has been widely predicted and it hasn’t happened. We have got concerns in China, number four, three is continued weakness in Europe, two are the emotions of those conflicts that we see, including across Syria and Iraq and then of course, leading the way, one, Central Bank policies. What are investors most concerned about today? I think that is an interesting poll question, we need your answers right now so we can get to that before we end our session.
I want to summarize, in our last 20 minutes here the to-do list within an unscripted recovery. Ron, I think the easy answer for you is, I need to participate in the equity markets, I need to be in equity markets, but I have to have a certain radar up and a certain caution. Is the easy radar just to have cash on hand?
Ron Sloan
I think so. Really, from an asset allocation standpoint, you have got stocks, bonds, cash, and so if we’re dealing with, as Greg said, basically, a rate game, a coupon market in the bond market, then you come down to equities and cash and many blue chip equities, the dividend yield equities, they're not competitive. I think they have got other issues, in my view, so what you're really left with is more economically sensitive companies and cash, and that is really – we’re talking about a barbell and so there is nothing wrong with that, because the market will give you enough oomph and beta if you're right on the economically sensitive part to offset some of that cash. Be cautious, pay attention, let’s see a better third quarter than I think the markets are expecting in those economically sensitive parts of the economy.
Tom Keene
With that statement, can we make, whoever we are, our actuarial assumption, can individual investors, smaller institutions and those large institutions with horrific pension obligations, are they going to be able to make their actuarial hurdle given that barbell strategy with a bond market that is not helping out like it did for a decade.
Ron Sloan
On a fully funded conservative actuarial assumption, yes, they can, but not…
Tom Keene
I think with that many symbols you can do anything.
Ron Sloan
But where we have gotten into trouble is on the public end, on the pension end and certain kinds of businesses, they have taken liberties with that actuarial assumption so they didn’t have to put money into the funds each year and that is where they have gotten into trouble, they have stretched for returns and that has gotten them into trouble. For those companies, no. for those plans, no, but for conservative plans, I think they can.
Tom Keene
I think Ron, just that you can decade off Greg, it is a challenge, it is a coupon market, we all agree with that, 2009 was great, 2012 was great. How do you prepare for your unscripted fixed income markets?
Greg McGreevey
I think the playbook for us a relatively straightforward one. We have got to look at economic growth and some of those risks, but in general, if we’re right on a low to moderate growth in inflation environment, then we still can have opportunities in fixed income, it can still provide income, it can still provide income with limited volatility, but clearly, we’re not just going to be able to be in the market and stay in the market, we’re going to have to be more active.
Tom Keene
Where are those best opportunities? Are they in senior loans; are they in investment-grade paper?
Greg McGreevey
I think they're in corporate bonds, I wouldn’t say today, because we’re kind of going through some technical issues, but over time, they're going to be in corporate bonds, high yield, and bank loans, to a lesser extent global investment-grade and then select of the EM market, so that is on the credit side. I think there are significant opportunities because of this divergence in this unscripted world within currencies and rates and we can spend the next 45 minutes talking about all those opportunities, but I think credit rates and currencies have their own idiosyncratic opportunities, but in general, if we’re right on the macro environment, then we think that credit is going to perform okay.
Tom Keene
Then, John, with the prescription within an unscripted recovery, that thing that is in the back and it is Rudi Dornbusch and it is Rogoff and the rest is, boy, currency solves a lot of problems. When in doubt, depreciate, when in doubt, devalue. Is that really where we’re heading, a race to the bottom, except the Dollar?
John Greenwood
I don’t think so. There will be some countries where the currency depreciates, but as I said earlier, the key is not how much advantage you gain by devaluation, the key is ensuring that domestic demand grows adequately. Take the Eurozone again, the Eurozone is running a huge current account surplus, but it is also running huge unemployment levels, those are both signs of deficit domestic demand, so even if the Euro falls to 1.10 or lower, you're still going to have weak demand in Europe. What we need is stronger demand. In a world that has been dominated by too much debt, in a system where debt or credit is created through the private sector, it is very difficult to create credit, that is why we had QE, so longer term, the challenges to get balance sheets back into shape sufficiently that those animal spirits pick up again.
Tom Keene
Well, rip up the script with a problem child known as France, France has their monetary policy run out of Frankfurt, Germany, they have got certain regulations run out of Brussels, and then they have t heir political system. How do you envision France finding that domestic demand?
John Greenwood
I don’t. I think it is going to be a long struggle, that is why I think that this divergence is going to persist for a long time; we’re going to be in an environment of Dollar strength for a long period of time. One of the ways of expressing the problems of the Eurozone is that they don’t have enough political union to take the critical decisions, whether it was bailing out the banks or injecting new liquidity or whatever, but at the same time, they have this monstrosity in Brussels, which is constantly issuing rules and regulations…
Tom Keene
Be careful, they buy a lot of Bloomberg terminals.
John Greenwood
They have too many rules and regulations, which inhibit the adaptability of the private sector, so you don’t have that decision making power, but you also don’t have the ability to adjust in the private sector.
Tom Keene
I did a poll on my staff the other day in the Plaza Accord on they thought that was whether, should they buy Gucci or Bottega Veneta. Nobody knows what the Plaza Accord is, do you envision stronger Dollar is it a Rubin 1995 strong Dollar policy, or is it even more hysterical like what we saw, and I can’t remember, ’71/’73 and then on from there, it is Dollar straight up.
John Greenwood
This is market driven; we’re not going to need a Plaza Accord for the Dollar to strengthen steadily over the next two to three years. That is going to be something of a headwind for US exports, but as long as the US domestic demand is growing fine then I don’t think it is a problem.
Tom Keene
Here is our poll results, very interesting results of the concerns that you have. Conflict around the world, 42%, I can understand that after the summer that we have seen. Central Bank policies, 38%, I think that is way too harsh, I gave a better grade to the Central Banks, that adds up to around 80%. John, quickly, I want to go around the table on this, what grade would you give the Central Banks?
John Greenwood
I don’t think you can give a single grade, the problem is that we have got the Fed and the Bank of England broadly having done the right things, the ECB not having done the right thing. It is kind of two completely different grades; an average isn’t meaningful in those circumstances.
Tom Keene
I don’t know if it is two, three, standard deviations, but Euro goes like this off economic news, Russian Ruble goes like this off capital controls or whatever. Do you care what Janet Yellen says at her press conference, in terms of Central Bank policy. The day to day of Invesco equity investment, does it rely on an interpretation of the Central Bank?
Ron Sloan
Since I want Janet Yellen to get out of the way and let natural forces occur, I guess I don’t care, but the longer she stays in the way, then I do care. I would like Ms Yellen to get out of the spotlight.
Greg McGreevey
But I think one of the things too when you look at the market, Tom, and I think you said it, Ron, a couple of times, the Central Banks across the globe have really done a tremendous amount and you can say, both sides have done a great job and try to give them a grade, but the reality is, they did a couple of things in trying to increase asset prices, trying to get confidence up and then have a tertiary impact of that on pricing overall. That all being said, I do think that the prospect for a policy error, given the fragility of economic formation that we have talked about here is pretty significant, so if the Fed were to begin to raise rates very aggressively, like they have over the last number of cycles, and really flatten the curve out, that could have some pretty significant implications.
Tom Keene
Well, in the final minutes that we have got, Greg, let me start with you and this vogue right now of, I want to go to all three of you an unscripted idea, one word, non-traditional. Non-traditional bond funds, I believe a bond fund is where you put in your money in whatever the flavor is, it is there and there is a yield and there is a potential for a total return. What is a non-traditional fund away from that core idea?
Greg McGreevey
Tom, a non-traditional bond fund is simply a bond fund that has broad investment opportunities across typically rates, credit and currency, as an example, that allows a manager to decide where, across those markets, they should be investing in, to be able to do broad asset allocation as well as risk management, to come up with, typically, a product that is going to provide a return, some level of income and some level of downside risk protection.
Tom Keene
The real idea is greater manager flexibility.
Greg McGreevey
Greater manager flexibility across a broadened asset set than many traditional fixed income products.
Tom Keene
What does a non-traditional equity strategy look like? Is it just buy the Dow and buy and hold and push it over there. How do you be non-traditional in equity markets, given the unscripted moments we have had?
Ron Sloan
I think being active would be the first thing, not looking to can the solutions, so I talked about the barbell earlier, that would be an unconventional strategy, because so many people are using – and we have a large ETF component of our company, but using manufactured or canned responses for sector weightings or style weightings or all these different kinds of banks.
Tom Keene
You have to malleable.
Ron Sloan
I am a stock picker and so it is about reading perspectives, it is about making decisions about asset allocation by corporate managements, and it is investing in companies, I think you are to some degree, kind of like private equity, you're going to have to invest in these things for a little bit longer than you probably used to, but it is all about making a good buy decision. The old retail adage, merchandise well bought is already half sold, that is what I think most investors are going to have to do in equities and then keep a big dollop of cash on the side for that.
Tom Keene
Within the unscripted recovery, John Greenwood and we have seen it with your Hong Kong and your Scotland as well. I didn’t know what the script was until 2 in the morning, I think we saw, in one of the distant islands or whatever, oh, they said no. everybody went…Alistair Darling went, Yes! Within the unscripted moment that we’re in, does this continue, does the word I have used too much recently, Scarlet Fu, the cacophony that we have been living in, and your geopolitics and geoeconomics, does that continue?
John Greenwood
Yes, I think that kind of noise will continue and the important thing is to, if you like, in engineering terms, to extract the signal. The key signals, the fundamentals, if you like, are the business cycle, the gradual recovery, and the handover of the baton from the Fed to the commercial banks. If we can get that right and the commercial banks start creating money and credit, the business cycle picks up in a gradual way, then we have the opportunity for an extended recovery with low inflation. It is not guaranteed, but the prospects of that, at the moment, are looking pretty good, because with the private sector still in balance sheet repair mode, those animal spirits haven’t really been let out of the bottle, and therefore, credit, we’re not going to have the sort of wild exuberance that Greenspan talked about in the ‘90s, I think we will have much more modest growth in money and credit and that means that we should have a longer period for solid markets, an earnings driven market in equities and low bond yields staying relatively low and therefore good returns available selectively in the bond markets.
Tom Keene
We will leave it there with some optimism as well. The script says I have to end the unscripted recovery discussion. John Greenwood, Gregory McGreevey, and Ron Sloan, thank you, as always and all of Invesco. That wraps up this edition of the Invesco Interactive Webcast Series, but the conversation does not stop here. Visit Invesco’s website to read in-depth insights and timely blog posts from their portfolio managers. Again, thank you to John, Greg, and Ron for sharing your thoughts and thanks to all of you, our viewers, for your time and for the questions you submitted.
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Important information
All investments are subject to risk and may lose value.
Fixed income investments are subject to credit risk of the issuer and the effects of changing interest rates. Interest rate risk refers to the risk that bond prices generally fall as interest rates rise and vice versa. An issuer may be unable to meet interest and/or principal payments, thereby causing its instruments to decrease in value and lowering the issuer’s credit rating.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The Invesco Interactive series is provided for informational and educational purposes only. The opinions expressed are those of the speakers, are based on current market conditions and are subject to change without notice.
Tom Keene and Bloomberg News are not affiliated with Invesco Ltd. or its subsidiaries.
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