Point of View Economy – Markets – Investment Strategy …€¦ · Welcome to the\ഠAdvisors4Advisors webinar series. Fritz Meyer is going to be giving you his wonderful new update,
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Point of View Economy – Markets – Investment Strategy September 2019 1
Point of ViewEconomy – Markets – Investment Strategy
September 2019
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Presenter
Presentation Notes
Andrew Gluck: Welcome, welcome, everybody. Thank you for being with us. Today is Tuesday, September 10th, 2019. Welcome to the Advisors4Advisors webinar series. Fritz Meyer is going to be giving you his wonderful new update, get started in just a minute.
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Important Information
The views and opinions expressed are those of the speaker, Fritz Meyer and aresubject to change based on factors such as market and economic conditions.These views and opinions are not an offer to buy a particular security and shouldnot be relied upon as investment advice. Past performance cannot guaranteecomparable future results.
Presenter
Presentation Notes
Please take a moment to read this important information.
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Important Information
Performance quoted is past performance and cannot guarantee comparable future results; currentperformance may be higher or lower.
Results shown assume the reinvestment of dividends.
An investment cannot be made directly in an index.
Investments with higher return potential carry greater risk for loss.
Investing in small companies involves greater risks not associated with investing in more establishedcompanies, such as business risk, significant stock price fluctuations and illiquidity.
Foreign securities have additional risks, including exchange rate changes, political and economicupheaval, the relative lack of information about these companies, relatively low market liquidity and thepotential lack of strict financial and accounting controls and standards.
Investing in emerging markets involves greater risk than investing in more established markets such asrisks relating to the relatively smaller size and lesser liquidity of these markets, high inflation rates,adverse political developments and lack of timely information.
Fluctuations in the price of gold and precious metals often dramatically affect the profitability of thecompanies in the gold and precious metals sector. Changes in political or economic climate for the twolargest gold producers, South Africa and the former Soviet Union, may have a direct effect on the priceof gold worldwide.
Presenter
Presentation Notes
Before we get started, I would like to call your attention to our cautionary statements on the following slides. I will give you a moment to read it. It basically tells you that we are going to share opinions and estimates with you and that these should not be construed to be fact or any type of guarantee against market loss.
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Questions➢ With an inverted yield curve and trade war are we headed for recession?➢ Do negative bond yields point to global recession?➢ Are rising federal deficits and debt going to sink the U.S. economy?
Point of ViewSeptember 2019
Answers➢ Apart from manufacturing, the economic data continue to look good. Consumer income, spending and
net worth have never been stronger and will likely sustain U.S. economic growth. I think Chinese tariffs have been way overblown by the media. US nominal GDP is around $21 trillion, while US exports to China totaled just $108 billion (0.5% of GDP) over the past 12 months through June, and imports from China totaled $509 billion (2.4% of GDP) over the same period.
➢ Negative bond yields in Europe and Japan are with us to stay; they are driven not by economic weakness but rather by unprecedented demographics and a global savings glut and they will continue to exert downward pressure on U.S. bond yields. For balanced portfolios we must revise lower our expected portfolio returns for the foreseeable future.
➢ No. The U.S. has ample wherewithal to solve our deficit and debt problem … we just lack the political will to do so. Over time, Washington will be forced to get serious about managing spending and raising revenue. I don’t see an ultimate debt cataclysm.
For representative use only. Not for public distribution.
Presenter
Presentation Notes
Gluck: Fritz, we can see your question and answer slide on fullscreen. That looks great. And thank you for doing this, as always. And take it away.
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Stock Market➢ stocks have Powell protection➢ adjusting to protracted China trade war ➢ adjusting to earnings deceleration➢ stocks are fairly valued➢ inflation is tame
Point of ViewSeptember 2019
Presenter
Presentation Notes
Fritz Meyer: Thanks, Andy. Hi, everybody, and thanks for inviting me back once again this month. I’m going to set my clock for 60 minutes and, as Andy said, it could go over that. I’ll try not to do too much of that. Before I get started, though, I’d just like to repeat something Andy said. In addition to these monthly webinars, I talk to Andy every week about one idea or another, and what’s current, what’s topical. And he’s been doing a terrific job, I think, in packaging just one idea at a time, using appropriate graphics, effective graphics, in an effort to give it a, let’s call it, sound bite video bite. But a short but sweet message on something that’s, I think, important. And putting that in a packaged format that you can use with clients. Yes, of course he charges for this, but I just want to encourage you to sign up to get this continuous flow of material that you can use and put it right out to clients in addition to this monthly dose, more in-depth dive into the whole panoply of economic market and investing data. So again, I just want to thank Andy for doing such a terrific job in doing that. And I really enjoy speaking with him every week about what’s current. I thought once again, this month, that I’d start with some questions. I got some nice feedback last month from our first attempt at that, and I thought again it would be appropriate this month because these three questions I think are the most frequently asked of me. And they seem to be the most frequently addressed in the media. First is, with an inverted yield curve and trade war, are we headed for recession? My response to that is no, I don’t think so. I really don’t. Apart from manufacturing, where we are seeing weakness and intensifying weakness. But remember, manufacturing is only 10 percent of U.S. employees. I focus on the employee number because to me it’s people’s jobs and income that are at stake in manufacturing, but actually last month we saw continued additions to manufacturing jobs. So even though we’re reporting slowing in manufacturing, actually manufacturing employment continues to grow. So, that being the case, as manufacturing affects the total demand for goods, consumer spending, which is 70 percent of the U.S. economy, I don’t see a drag there. But beyond that, if you look at consumer income spending and household net worth data, we’ve never seen a stronger situation than we do today in the U.S. economy. Let me say that again. I’ve never seen such strength and momentum in consumer spending as we’re seeing today, albeit in the late phases of an economic expansion. But we’re really seeing that then reflected in extraordinarily strong retail sales, which continues to drive GDP growth. And with that kind of momentum, I just don’t see that rolling over on a dime so that we’re headed for recession in the immediate quarters ahead. And the other part of the question is, well, what about the trade war? And as I’ve said before, so I know I’m repeating myself, but I think Chinese tariffs and the trade war have been the most overblown story by the media in a long, long time. I’ll show you why I say that in a second, but one of the statistics that’s important to remember is U.S. nominal GDP is today around 21 trillion, and U.S exports to China at 108 billion comprise just a half of 1 percent of GDP. And mind you, those exports aren’t going away. They’ve been cut back but they’re not going away. And likewise on the import side. We will continue to import stuff from China. Consumers might pay a little bit more, but with such strong income — and, more importantly, the savings rate is at a record all-time high — I think Americans actually can afford to spend a little bit more, if that turns out to be the case, on retail sales. And paying the tariff in the meantime. So, no, I don’t see an inverted yield curve and a trade war pushing the U.S. into recession any time soon. Do negative bond yields point to a global recession? This is also another argument that’s often being made in the press. And this pertains to Europe, not the United States, because we don’t have negative bond yields. But negative bond yields in Europe I don’t think are symptomatic of economic weakness. Yes, we see economic weakness in Europe, but I don’t think bond yields are reflecting that. I think negative bond yields actually are driven by demographics and the European Central Bank, those two things. But I don’t think negative bond yields are reflecting extraordinary weakness in the U.S. economy. Actually, the most recent Purchasing Managers’ Index for Europe ticked higher. Germany is particularly weak, but France actually posted some pretty decent numbers most recently. So even in Europe I don’t think we’re headed for recession. Mario Draghi, by the way, said that yesterday. He doesn’t see the onset of recession in Europe. So, no, negative bond yields aren’t pointing to global recession. They are reflecting something else, which I’m going to go into in a lot of detail today. And then finally, are rising federal deficits and debt going to sink the U.S. economy in the end? I don’t think anyone believes this is going to happen overnight, but a lot of people have this gnawing suspicion that in the end this is all going to end badly because our deficit and debt are out of control [laughs]. No, I don’t think that’s going to be the endgame, and I’ll explain why I say that. The most important takeaway on this topic is the United States has ample wherewithal to solve our deficit and debt problem. We just lack the political will to do it. And the reason for that, again, going back to Simpson-Bowles ten years ago. I don’t have time to go into the details of that. I’ll just refer to Simpson and Bowles delivered to President Obama at the time a very sensible set of proposals to trip and snip away at the entitlement program spending, which would set it on a more sustainable course. And the president threw that set of proposals in the wastebasket because at the time he concluded that that’s a non-starter with the American public. The entitlement programs are ranked very high in the opinion polls. Nobody wants to see cuts to Medicare, Medicaid, and Social Security. And I think the current president also has that same view. So it seems to me that if you’re not going to cut spending in the long term, you’re going to have to raise revenues. And my point simply is that, oh, yeah, we have ample resources. We could raise additional revenues. And the bottom line on this is actually not a gargantuan feat at all. And again, I’ll save the punch line for the analysis, but we just don’t have the political will. So in the end, I think Washington, over time, on an incremental basis — gradualism, here, is the watchword — will be forced ultimately to get serious about managing spending and raising revenue. Maybe some combination of both. Maybe just raising revenue over time. And they will do it in the end, when forced to. A trigger event might be something like Standard & Poor’s drops the U.S. sovereign debt rating again to single-A, or something like that, and then Congress wakes up and says, “Well, we gotta do something about this.” My point is that because we have the lowest total tax burden in the world by far, the United States can afford to do this. We just don’t want to do it, but we will ultimately do it.
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Stock marketS&P 500 volatility
Source: Standard & Poor’s. data through September 6, 2019.
S&P 500 Daily Pecent Changew/30-day Moving Average
Remember the basic axiom of investing in common stocks: over the long term investors
earn the equity risk premium precisely because they expose themselves to price volatility, also
known as risk.
➢ 2% moves have occurred on average every 33 trading days.
➢ A 2% move is 520 points on the DJIA.
Presenter
Presentation Notes
Meyer: OK, let’s talk about the stock market. Again, the starting point I want to make this month, as I always do, relates to volatility. And again, I’m starting with this point this month because we’ve seen once again a resurgence of volatility here in August and September. And you can see that the most recent surges were — and I’m using my cursor here; I hope you can see it — in May of last year, and then in December of last year, and then once again in August of this year. These resurgent volatilities, nobody likes it. Least of all, your clients [laughs]. But my point, again, remains to remind clients, just go [laughs] just … I can’t over-stress how important this is, to educate clients in this regard. Your job as advisors is not to try to move people in and out of the stock market, trying to sidestep or avoid or outsmart the market, trying to avoid the next downturn. By the way, volatility surges on downturns. It never surges on the upside. So these are downward surges in the market. Your job is not to try to sidestep or avoid these. And I say that because it’s impossible for you to do it, and we all know that. That’s called market timing, and we all know the statistics on market timing. You can’t make successive accurate calls in the market and come out ahead of a simple buy-and-hold strategy. So what I’m suggesting here is remind clients that volatility is actually your friend. The only reason we as investors have earned the 6 percentage point equity risk premium, not just over the last 50 years, but 200 years of U.S. financial history, is precisely because we’ve sought out an asset class that’s volatile. Remember, there’s no such thing as a free lunch in the world of investing. Risk and reward. Risk is measured as a standard deviation of daily or monthly returns. It’s a measure of risk. So in order to earn that 6 percentage point equity risk premium, we deliberately make the choice to seek out an asset class that’s going to be volatile. We know it’s going to be volatile, and we’re looking for it. So why would anybody be surprised or shocked or scared when we do get that volatility which, as I say, always occurs to the downside? And the last point I’ll make on this chart is that today … Well, two points. First of all, 2 percent moves have occurred on average every 33 trading days. That statistic shocked me, which is why I keep bringing it back to you. That’s pretty frequent. And so my new plan in my own portfolio is never buy a stock except on a down-2-percentage-point day. In other words, [laughs] just be patient. Be patient. It’ll happen. On average, every 33 days the market’s going to take a 2 percent hit, which today is 520 points on the Dow. Enough to scare the daylights out of you 20, 30 years ago, when I got in the business, when a 50-point move on the Dow was scary. Today it’s 520 points. And again, that’s just routine. That’s a 2 percent move. Don’t let it bother you. Ok, so the next slide is the stock market itself. Hold on. I’m trying to get my cursor to work.
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Stock marketS&P 500 – all about the Fed
Source: Standard & Poor’s. Data through September 6, 2019. 1The Wall Street Journal, December 21, 2018. 2 J.P. Morgan Equity Videocast, June 4, 2019.
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Presenter
Presentation Notes
Meyer: OK, so here’s the stock market. And I’ve drawn these purple bottoms in to emphasize this point: It’s all about the Fed. It’s not about trade. In other words, the big moves and the big recoveries in the last six months have all been related to what the Fed has said or done. The story started in October 3rd of last year when Chairman Powell said we’re a long way from neutral. Whoops, wrong thing to say. And then he compounded the problem on December 19th when they actually raised rates and continued to maintain that we’re headed to 3 percent on the fed funds target rate. Whoops, another 500-point plunge on the Dow. In other words, investors were way ahead of the Fed on this, saying, “Are you crazy? You’re going to invert the yield curve very significantly, and we all know what happens with an inverted yield curve.” To me, the Fed’s moves were baffling. Nonetheless, on January 4th, Chairman Powell did finally take the message from the market. And he said, “OK, that’s all off the table. We’re not going to continue to 3 percent on the fed funds target rate, and rates will be on hold.” So he put in the bottom. OK, the next episode, similarly, was the yield curve did invert. My definition of the yield curve, by the way, is 10-year Treasury minus fed funds target. I know some people use 3-month T-bills. I know some people use the 10/2. I use 10 versus fed funds because that’s actually the measure that’s incorporated as one of the 10 subindexes in the indexes of leading economic indicators. And that’s the one that finally inverted on May 13th. And so that was a scary event, and you can see the stock market was selling off. And then the Fed steps up on June 4th and says, “We will act as appropriate to sustain the expansion.” And so that was music to the investors’ ears. And then it was all up, up, and away until we hit a record all-time high on July 26th. Market’s been selling off, and once again the Fed said, “We will act as appropriate to sustain the economic expansion.” And he said that again last week at Jackson Hole. Once again, the bottom is put in under the stock market. Yes, I know his tweets on the trade situation have whipped stock prices higher and lower, but only at the margin, is my point. I think that the significant thing is what the Fed has been saying and doing, and how the Fed ultimately handles this situation. Before I leave this chart, just two other observations. On December 21st, as is typical, David Rosenberg, the permabear, at least a guy who’s been very bearish all along, almost simultaneous with the bear market bottom on Christmas Eve, said the economy will be in a recession within a year. I’m just citing David Rosenberg because he is in fact a very high-profile guy. Formerly Merrill Lynch’s chief market strategist. Now at a smaller firm in Canada but, nonetheless, somebody who is repeatedly featured on CNBC and has consistently been on the bearish side of opinion with respect to the stock market. So I want to juxtapose Rosenberg’s opinion with David Kelly’s opinion. On June 4th, David Kelly said … And since then I’ve noted he’s been on TV several times, and I think most of you on this call know who Davis Kelly is. He’s J.P. Morgan’s head guy, chief strategist, and he says the yield curve is a broken barometer. And he remains positive on both the outlook for the economy and stocks. So my point is simply this: There are two very high-profile, very seasoned, very experienced Wall Street veterans with diametrically opposed views on the current outlook. Which will turn out to be correct, I don’t know.
8 Source: CNBC screenshot, August 27, 2019.
Stock marketS&P 500 – bearish strategist
David Rosenberg is sticking with his recession story.
Presenter
Presentation Notes
Meyer: But one of them will turn out to be right, and one wrong. Now, David Rosenberg, I noted … Isn’t this amazing? I took this picture with my iPhone as I was watching at my desk working the other day. But David Rosenberg is sticking with his recession story. This is August 27th, so he continues to be bearish, citing a whole host of things, inverted yield curve among others. I actually don’t agree with his assessment.
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Stock marketConsumer spending
TGT
HD
WMT
It’s hard to imagine we’re headed for recession with these stocks hitting all-time highs.
Presenter
Presentation Notes
Meyer: But I’m not here to give you opinions. I’m here to give you the numbers. And I’ll show you why that’s my conclusion. Among other things, I just wanted to show you these three charts. This is Target, Walmart, and Home Depot. All at record all-time highs. It’s just hard for me to imagine that we’re headed for recession with these major retailers all hitting record all-time highs. It’s also such an irony that there’s so much pain in brick-and-mortar retail land. Companies going bankrupt. Barneys going bankrupt. A lot of the retailers having a really tough time, but those are the retailers that missed the boat. They just didn’t understand the changing nature of retail. Whereas the major retailers who have done a good job, both online and brick-and-mortar but, more importantly, for whom there is no substitute, continue to make record all-time highs. If you look carefully at these charts, which is what I was doing when I compiled this, you see that these stocks started to sell off well in advance of the 2008 recession. They started to lose ground early to mid 2007. So if the last example is any guide, having these stocks hitting record all-time highs as we speak just doesn’t suggest to me that things are going to turn. And remember, Rosenberg’s statement was, “We’ll be in recession by the end of the year.” That just doesn’t look likely at all with the strength in consumer spending as reflected in these retail stocks.
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Stock marketStill “risk-on”
Source: Marketsmith, Inc. September 6, 2019.
Golden crosses.Death crosses.
Golden crosses have given pretty good market signals and aren’t all that frequent.
Presenter
Presentation Notes
Meyer: The other chart that I [laughs] really do enjoy is this one, talking about golden crosses and death crosses. And as you’ve heard me say before, probably, I pay no attention to the technical analysis. To me, it’s mostly ouija board stuff. It’s trend following. It works till it doesn’t work. But this one, on the other hand, really is interesting because golden crosses have given pretty good market signals and just are not all that frequent. And yet, we had a golden cross here at the beginning of this year. All we’re doing here is measuring momentum in the stock market. It’s the 50-day moving average versus the 200-day. And when the 50-day moves up through the 200-day, that’s a symptom of increasing momentum, whereas the death cross is the other way around. And those two have been pretty good sell signals. I mean, if you’re at all inclined to buy and sell based on these type of indicators, well, the death crosses have signified some real heavy weather in the stock market, which has persisted for one or several quarters. And conversely, the golden crosses have persisted for, in the period ’11 to ’15, for four years. So that’s the significance I attribute to the golden cross versus the death cross.
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Stock marketStill “risk-on”
This market-based measure of risks to the economy spiked last December.
It has spiked spuriously many times in the past.
Source: ICE Benchmark Administration Limited (IBA), ICE BofAML US High Yield Master II Option-Adjusted Spread [BAMLH0A0HYM2], retrieved from FRED, Federal Reserve Bank of St. Louis. Monthly data through August 2019; and last data point September 5, 2019.
Meyer: Here’s another measure that’s often cited in the media and pundits in Wall Street. It’s the junk bond spread to Treasuries. And you can see that this thing spiked in 2015. In other words, it gave a false positive, which is what it is wont to do. So I don’t actually put much stock in this. But to the extent that people are saying recession is on the way, well, you could fool me by looking at this chart because in the past when recession has been on the way, this thing has gone higher, and in some cases absolutely blown out, when the risk in high-yield compared to the risk in Treasuries has become extreme. And you’re not seeing anything like that today.
12 Source: Federal Reserve major currencies index. Monthly data through July 2019; last data point August 30, 2019. 1Federal Reserve, Remarks by Chairman Alan Greenspan before the Economic Club of New York, March 2, 2004.
U.S. dollar ($)U.S. Dollar index – trending sideways
The dollar’s surge created a headwind for S&P 500 earnings in 2014-15.
Trending sideways since then.
“… no model projecting directional movements in exchange rates is significantly superior to tossing a coin.”-- Alan Greenspan1
+0.9%% YTD+2.7% y/y
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Presenter
Presentation Notes
Meyer: Also, the U.S. dollar is sometimes cited recently as being problematic for the stock market. And here the argument is, “Well, the dollar’s been so strong. That’s going to be hard for corporate earnings because they repatriate foreign earnings and repatriate [it in?][20:04] dollars, and it takes away from U.S. dollar reported earnings.” And I say nuts to that. That’s not true at all. It’s just a false statement. The dollar’s only up 2.7 percent year-over-year, and it’s actually up less than 1 percent year-to-date. So it’s just not the case that we’ve seen extraordinary dollar strength. The dollar’s been more or less trading sideways now for almost five years.
+9.7% per year S&P 500 total return over the last 27 years is in line with the stock market’s long-term returns going back to 1926, or back even further to 1871.3
Source: Standard and Poor’s. Data through September 6, 2019.1 Compound annual growth rate. 2 S&P 500 total return index. 3 per Professor Jeremy Siegel’s seminal Stocks for the Long Run, first published in 1994.
Meyer: So, back to the stock market. Here is the picture of the S&P 500 total return. And again, since I cover this ground every single month … By the way, I do that not only to keep an eye on this, but also for people who are new to this call. I just really think this is such an important observation. If you think that the recovery in the stock market from the post-recession low of March ’09 to the present day is some really extraordinary event, which one could be forgiven for concluding since it’s a quadrupling in stock prices … There’s almost no corrections. Only one significant correction along the way. So you could be forgiven for thinking that, well, this is really unusual. This isn’t the way stocks work. It’s not a one-way bet. We all know that. On the other hand, it is nothing extraordinary when one considers that the quadrupling in stock prices from the March ’09 low to the present day has represented nothing more than a reversion to the long-term trend rate of appreciation in the stock market, which is approximately 10 percent. And that was the figure that Jeremy Siegel spent so much time validating, going back to 1926 and, on a little skimpier data, 1871. And on even sketchier data, but nonetheless, all the way back to 1802 stocks have delivered approximately 10 percent over the long term. So this is nothing unusual at all. And yet it can be a frightening chart because it looks like it’s just going parabolic, as they say in Wall Street. And by the way, if this looks scary to you now, it’s going to get a lot scarier looking because when you compound a data series at a constant rate it eventually approaches an asymptote, which is a vertical line. And that’s exactly what this thing’s going to look like, increasingly over the next decade.
On a logarithmic scale a constant rate of appreciation, say 9.7%, is represented by a constant interval on the y-axis, say one-eighth of an inch.
Hence, the +9.7% growth trajectory is a straight line rather than a hyperbolic curve (previous chart).
Presenter
Presentation Notes
Meyer: So if you correct for that arithmetic compounding effect and put it on a logarithmic scale, you can see the stock market total return is actually trending higher on precisely a straight line. And that shouldn’t concern anybody. And interestingly, we are right where — right where — one would expect to be, given that long-term trend rate of appreciation. By the way, you can see what an extraordinary valuation aberration looked like in and around irrational exuberance in the year 2000.
1 2018 (actual), 2019 (estimated) and 2020 (estimated) bottom-up S&P 500 operating earnings per share as of September 3, 2019: for 2018(a), $161.93; for 2019(e), $164.61; for 2020(e), $183.35. Sources: Yardeni Research, Inc. and Thomson Reuters I/B/E/S for actual and estimated operating earnings from 2015. Standard and Poor’s for actual operating earnings data through 2014.
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Presenter
Presentation Notes
Meyer: So, 7 and a half percent price appreciation in the stock market, the black line in the previous chart, is what we have seen. And my question for you is, well, what do you think drives that? What drives this extraordinary engine of wealth creation here in the United States at 7 and a half percent compounded annually, as I said, over 200 years? And when you add dividends and reinvest them, the number’s closer to 10 percent. And the answer is earnings. Earnings drive stock prices. In the very first chart, what I showed you is that stock prices are up, I think it’s about 18 percent year-to-date, but year-over-year stocks have gone precisely nowhere, which makes it additionally hard for investors to understand. “You got all this volatility and we’ve gone nowhere in the last year?” Yep. That’s the way the market works. What’s happened is that investors had to digest this fact, that from this extraordinary surge in earnings of 23 percent in 2018 — half of which, by the way, was attributable to the tax cuts — then going into 2019, investors had to really recalibrate their expectations to a measly 2 percent earnings growth expected this year. And that, more than anything, explains to me why stocks have done nothing over the last 12 months, point to point, because investors had to realize that earnings growth has essentially stalled. Now, as we look ahead and continue the story, what’s interesting to me is that the expectations for next year’s earnings actually have remained quite solid at up 11 percent year-over-year. And that number has, as I said, remained quite solid. It was 12 percent four months, three months, two months ago, and it’s been only shaved by one percentage point just in the last month. And it may come down further, by the way. I think it actually could come down further. But the significance of that estimate is this. First, ask yourself who’s coming up with these numbers. Well, this is the legion of analysts in Wall Street who pester chief financial officers every week, saying, “How’s your business?” And evidently, they continue to come back with the answer from the S&P 500 companies that business looks pretty good. As we look out into 2020, business looks pretty good. And again, go back and juxtapose those statements and the information that’s embedded in this 11 percent earnings growth estimate against this notion that, “Woe is us. The trade war’s going to take us into recession,” and it’s just ridiculous. It’s laughable how overhyped the trade war thing has gotten. Again, perception versus reality.
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ValuationS&P 500 vs. actual and estimated earnings
1 2018 (actual), 2019 (estimated) and 2020 (estimated) bottom-up S&P 500 operating earnings per share as of September 3, 2019: for 2018(a), $161.93; for 2019(e), $164.61; for 2020(e), $183.35. Sources: Yardeni Research, Inc. and Thomson Reuters I/B/E/S for actual and estimated operating earnings from 2015. Standard and Poor’s for actual operating earnings data through 2014 and stock price index through September 6, 2019.
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Presenter
Presentation Notes
Meyer: So earnings drive stock prices, and this is S&P 500 earnings in red. The black is the stock market. And you can see how the two are so extraordinarily correlated positively. And so one could reasonably assume that, to the extent the earnings unfold in 2020 more or less along the lines that Wall Street analysts have it doing pursuant to the previous chart, the path of least resistance for stocks might be higher.
17
ValuationS&P 500 vs. 16X and 19X actual and estimated earnings
1 2018 (actual), 2019 (estimated) and 2020 (estimated) bottom-up S&P 500 operating earnings per share as of September 3, 2019: for 2018(a), $161.93; for 2019(e), $164.61; for 2020(e), $183.35. Sources: Yardeni Research, Inc. and Thomson Reuters I/B/E/S for actual and estimated operating earnings from 2015. Standard and Poor’s for actual operating earnings data through 2014 and stock price index through September 6, 2019.
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This is not a forecast or prediction.It’s simply a calculation of 16X and 19X consensus earnings forecasts.
Presenter
Presentation Notes
Meyer: Here’s another chart making that same point, but here I’ve introduced a valuation metric. I’ve applied a P/E ratio of 16 times on the low side and 19 times on the high side to the historic earnings, and gotten best fit here. And then I’m also applying those to these forward estimates. So you can see that at 17 and a half times, which would be the midpoint times the estimate for 2020, would lead one to conclude that stocks could reasonably trend higher between now and the end of next year, given what I consider to be a reasonable P/E ratio applied to the current consensus earnings forecast.
18
S&P 500 P/E ratio vs. inflation
Sources: Standard & Poor’s Corporation and Thomson Reuters I/B/E/S earnings estimates, BEA. Stock price data through September 6, 2019; inflation data through July 2019. Top panel, latest data point: 2979 ÷ estimated trailing operating earnings of $164.43 through 6/30/19 = 18.1X.
The S&P 500’s latest P/E ratio (9/6/19) on trailing 12-months operating earnings is 18.1X.
It is 16.3X on consensus bottom-up 2020 estimated operating earnings.
yields abroad and sub-2% U.S. bond yields are here to stay, a new era of higher P/E
ratios could result.
Presenter
Presentation Notes
Meyer: Now let’s address the market’s multiple explicitly, which is what you see in the top data series. And here, in the red data series, is the S&P 500 P/E ratio on trailing 12-month earnings, and it’s 18.1 times at present. It’s 16.3 times on 2020 operating earnings. By the way, in that calculation I’ve shifted forward from 2019 because we’re only less than four months away from the end of this year. So I’ve moved forward. But it’s 16.3 times on the 2020 earnings estimates. Now here’s a major point that I wanted to make this month that I haven’t said before, so I included this box. If investors, in fact, become convinced that negative yields abroad and sub-2 percent U.S. bond yields are here to stay, I think it is entirely conceivable that we enter a new era of higher P/E ratios. And I don’t think that calculation is any secret to any of you because I think we all understand that the market’s P/E ratio is a direct function of inflation expectations and bond yields. So if, in fact, investors come around to a notion … And this would be radically new, radically new, because we’ve never in the history of the world experienced negative bond yields, at least as far as I know. I’ve never read about any instance in which you have to pay the bank to hold your money or you have to pay a bondholder to hold your money. And yet, that’s the world today. Now, is this a transient phenomenon? Absolutely not. I don’t think it is. I don’t think it is. I think this is a new world. None of us have ever seen this. Nobody has ever anticipated this. It has seemed inconceivable, and yet that is, I think, what we’re looking at. And my point with respect to market valuation is, to the extent investors start to internalize this … And they haven’t done this yet. This is brand-new thinking. This is cutting-edge. You are witnessing [laughs] a once in all-time history shift, possibly, in sentiment. Suggesting that if bond yields are negative, then the only game in town increasingly becomes common stocks and yield on common stocks. Today’s dividend yield on the S&P 500 is about 1.9, I think. And a bond is 1 and a half percent. And the bond could actually go lower. It could go lower. So my point is to suggest that, first of all, 18.1 times trailing earnings is right in line with the historic norm for a low-inflation environment. But secondly and more importantly, to the extent that new attitudes take hold with respect to the direction for bond yields longer-term, P/E ratios could conceivably find new higher plateau sustainable levels. It only makes sense. It only makes sense because of the relative attraction of common stocks versus fixed income. Hope everybody understands that because I think it’s such a significant point.
19
Fed policy➢ engineering the soft landing➢ the Phillips Curve is broken➢ the Fed’s inflation forecasts have
consistently been too high ➢ inflation expectations trending lower for
past 15 years ➢ the Fed manages the yield curve➢ the Fed has created every recession since
the 1950s➢ “the Great Unwinding” – bond yields were
supposed to start rising, but they aren’t
Point of ViewSeptember 2019
20
Federal Reserve policyFed’s key policy lever is the yield curve
Source: U.S. Department of the Treasury.
This is an inverted (negative) yield curve resulting from the Fed’s raising the Fed Funds target rate. Recession followed.
Today’s yield curve looks very much like 2007.
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Last year’s rate hikes.
Lenders borrow short and lend long. Hence, as their cost of funds rise compared to the interest they earn on loans, they curtail their lending activity, putting a damper on the economy.
This policy lever is the Fed’s key means to act as a governor on the economy in order to forestall inflation.
Presenter
Presentation Notes
Meyer: OK, let me talk a little bit about Fed policy. And again, back to the recent history. Why did investors freak out last December when the Fed said, “You know what? We’re going to take the bond yield from 2 and a quarter to 3 percent in the course of 2019”? That’s literally what they said on December 19th. They said, “Were hiking and we’re taking it to 3 percent.” And investors pitched a hissy fit and said, “No you don’t.” They said, “We’re not going to own stocks anymore if you’re going to do that, because you’re going to throw us right into recession.” Look what that would have done to the yield curve. It would have extremely inverted the yield curve. Today’s yield curve is in red, and even today’s yield curve looks ominously like the yield curve in March of ’07.
21
Federal Reserve policyFed’s key policy lever is the yield curve
Sources: NBER, Federal Reserve. Monthly data through August 2019, last data point September 5, 2019.1The interest rate on the 10-year Treasury bond (long term) minus the fed funds rate (short term).
The Fed has inverted the yield curve.
Flat or negative yield curves have preceded recessions.
In 1995 and 1998 the Fed changed course, cutting the fed funds rate and averting recession.
Meyer: And in March of ’07, you see in this chart … By the way, what you’re looking at here is the time series calculation of the yield curve, the 10-year Treasury minus the fed funds target rate. And when that value has gone negative historically, you see recession has followed immediately thereupon. And you can see that this yield curve today is looking really negative by historic comparison. So it’s natural that people would say, “We’re headed for recession. It’s happened every single time.” Put it this way: Every recession has been preceded by a negative yield curve, but not every negative yield curve has been followed by recession. So that’s where we are today in the argument and the debate over this because, you see, back in ’95, the Fed almost inverted the yield curve but then did a quick about-face, saving the bacon. And we had another five years to run. In ’98, they did it again. In fact, they inverted the yield curve to a point even greater than today, but quickly changed course and gave us another three years of that expansion.
22
Federal Reserve policyRate cuts vs. the S&P 500
Rate cuts preceded the last three recessions. But, not every rate cut was followed by recession.
In 1995 the Fed cut rates reacting to a slowdown it had engineered.
In 1998 the Fed cut rates reacting to Russia’s debt default and buckling global debt markets.
Both were critical course changes that forestalled recession.
Sources: NBER, Federal Reserve and Standard & Poor’s. Monthly data through August 2019. Last data point September 5, 2019.1Th i t t t th 10 T b d (l t ) i th f d f d t ( h t t )
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Presenter
Presentation Notes
Meyer: And so this is investors’ hopes for today. We’ve already experienced one rate cut, here, and investors are hoping that the Fed executes on a ’95 or a ’98 style, taking back what they gave us in the way of rate hikes over the ensuing months and quarters, thereby averting recession.
23
Federal Reserve policyQuantitative easing, the monetary base and the money supply
Monetary base: currency in circulation plus reserve balances (deposits held by banks in their accounts at the Federal reserve).
M2: currency held by the public plus checking, savings and money market accounts.
A quadrupling of the monetary base did not affect M2 growth.So, a gradually shrinking monetary base should not affect M2 growth.
Source: Federal Reserve, statistical release H.3 and H.6. M2 data through July 2019; monetary base data through July 2019. 1CAGR = compound annual growth rate.
Meyer: One thing I wanted to correct was the president keeps saying that the Fed is restrictive in quantitative easing. To the extent that the Fed has not continued to buy bonds or, I guess, at a minimum, is letting their bond portfolio running off, that constitutes restrictive monetary policy. I take issue with that because it’s simply not true. So here I just wanted to call your attention to the history of quantitative easing. Here, the monetary base went from 800 billion to 4.1 trillion in the course of quantitative easing. And yet the money supply, up above, never deviated one iota from its long-term 5.9 percent trend, which is to say that quantitative easing had no effect at all on the real economy or the money supply that drives the real economy. Quantitative easing had a huge effect on the cost of long-term borrowing, which is what healed the banks’ balance sheets and what healed real estate. But to say that the Fed, by letting its bond portfolio run off, is engaging in restrictive policy is simply not accurate.
24
Bond Yields➢ lowest yields in history➢ yields don’t make sense by historic comparison➢ Fed’s QE took yields to those levels➢ the ECB continues to pin rates down
Point of ViewSeptember 2019
25
Bond yields Record low U.S. Treasury bond yields
Source: Online Data Robert Shiller, annual data through 2018; September 5, 2019 data from the U.S. Treasury Department.
The lowest long-term interest rates in U.S. history.
Meyer: Let me talk about bond yields because this chart that I updated this month is really surprising. We are now hitting a record all-time low. This chart goes back to 1871, and we’d never seen lower bond yields. I just thought that was an interesting development. Never seen lower bond yields on long-term Treasuries in the history of the United States, at least going back to 1871.
26
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Source: Moody’s, retrieved from Federal Reserve Bank of St. Louis. Monthly data through August 2019.
Approaching the record lows of the ‘30s, ‘40s and ‘50s.
Presenter
Presentation Notes
Meyer: Now, on the other hand, investment-grade corporates have not quite seen their historic lows. In fact, during the ’30s, ’40s, and ’50s, the AAA was lower than where it is today, as was the BAA. So we’re headed in that direction but we haven’t quite plumbed the depths yet. That was just an interesting dichotomy between the Treasury hitting a record all-time low versus corporates.
27 Source: FRBSL, monthly Bund data through July 2019; monthly Treasury data through July 2019. Latest data points September 6, 2019.
Bond yieldsECB QE is likely weighing on U.S. Treasury bond yields
These two have historically moved in lockstep, suggesting negative German yields are weighing on U.S. Treasury bond yields.
crosshatchesrepresent recessions
Fed QE ECB QE
Presenter
Presentation Notes
Meyer: OK, so this chart says a whole lot to me. One of the reasons that the Fed, I think, got it so wrong in their policy … And I’m not blaming them. I’m just trying to outline this set of facts which has come as a huge surprise to everybody. Back to Slide 30: Fed’s Key Policy Lever Is the Yield Curve Meyer: Remember, when the Federal Reserve said, “We’re going to take the yield curve from here to here on the short end, from 2 and a quarter to 3 percent,” they outlined that policy over two years ago. Two and a half years ago, I think, is when they first outlined that policy. And their assumption all along was that as the economy picks up steam, bond yields too will start rising as they’ve always done as we’ve come out of recession. “So if we push the short end to 3 percent, well, that’ll be in the context of the long end going to 4 or even 5 percent.” And my point with this chart is to suggest that that’s not what happened. Back to Slide 37: ECB QE Is Likely Weighing on U.S. Treasury Bond Yields Meyer: And in fact, here’s such an interesting statement from Jamie Dimon. One year ago, August 4th, a little over a year ago, Jamie Dimon said at the Aspen conference, “I think rates today should be 4 percent. You better be prepared to deal with rates 5 percent or higher. It’s a higher probability than most people think.” See, the smartest people in our economy, both the Fed and Jamie Dimon, and other bankers, said, “You know, the Fed wound down its QE in October of ’14—” And you can see this big bottom that’s being put in here in the red. The red is the 10-year Treasury bond yield. “—and we’re going to start trending back higher to 4 or 5 percent just as everybody thinks we should, and just like where we started out before all this QE stuff.” And lo and behold, that’s not what happened. The opposite happened. And the reason for this is the European Central Bank took control of our bond yields with its quantitative easing. When I say “took control,” it works like this. Bond markets are global. To the extent that European investors got less and less, and finally are paying bondholders to hold their money, that cash is flowing into the U.S. Treasury market. And this is the point that I think is so important to understand. This is unprecedented and I don’t think it’s going to go away anytime soon. In fact, I think it could be a permanent fact of life for us for the foreseeable future. And it is so at odds with what all the geniuses, all the smart people, and all the policy makers thought until very, very recently. Going back to the yield curve, then, what happened was, OK, the Fed says, “We’re going to go 3 percent.” But bond yields went the other way and the Fed was caught flatfooted, saying, “Whoa, we just inverted the yield curve. We’re planning to invert the yield curve even more. Does that make sense?” And they’re saying, “Nope. That’s exactly what’s not going to happen.” So they’ve had to reverse course. And again, I’m not assigning blame. I’m just talking about something that is the most remarkable transformation of fixed income world that probably any of us could ever have contemplated.
28 Source: World Bank, 2019. Data through 2017. Euro area includes the 19 countries that use the Euro currency, including Germany, France, Italy and Spain.
Bond yieldsEurope’s ageing population
Demographics driving a global savings glut.
Presenter
Presentation Notes
Meyer: And as I say, I don’t think it’s going away anytime soon. Why do I say that? This is Europe’s aging population. This is a single slide that speaks to this point about Europe’s aging population, 65 years and older. Remember, here’s 2020, so we’re looking at actual plots forecast. The number of Europeans 65 and older is set to accelerate substantially. Now, what happens when a society approaches retirement? People start squirreling away, socking away, as much as they can. What we’re experiencing is the term that Ben Bernanke coined over 10 years ago, a “global savings glut.” Well, I’m thinking we haven’t seen anything yet. You ain’t seen nothing yet on the global savings glut. And you’re seeing it in Europe, you’re seeing it in Japan, you’re going to even see it from China. This aging of global populations, accumulating massive savings that are looking for a home and safety. And at the same time, you can see 5-year-olds are declining, or flat. So it’s this aging population.
29 Source: Financial Times website, August 14, 2019.
Fiscal policy is driving dwindling supply of bonds.
Bond yieldsShrinking supply of Bunds
German government debt could “disappear.”
It’s no wonder that European bond yields are negative.
Presenter
Presentation Notes
Meyer: Then here’s an article that I clipped last week. From an article just published by the Financial Times about an analyst who is predicting the elimination of German sovereign debt. See, what’s happening in Germany is, because they realize they’re facing this aging population, then they’re running budget surpluses at present. The idea being they need to pay down their total stock of outstanding bunds because with an aging population they simply won’t be able to repay the debt over time. So they want to stay ahead of the curve. This analyst is saying the German government debt could disappear. So you see where I’m going with this? A global savings glut chasing a diminishing supply of Germany’s sovereign bond. Now, next to the U.S. Treasury, it’s the most senior and seasoned, and most desired, sovereign credit in the world. And it’s going away. It’s going away. So no wonder we’re seeing negative bond yields in Europe, which will continue to spill over here into the U.S. Treasury market.
30
Bond yields ECB – more monetary stimulus
Source: The Wall Street Journal, August 16, 2019.
Presenter
Presentation Notes
Meyer: And at the same time, the European Central Bank is set to reinstitute quantitative easing, according to this article.
This simple schematic illustrates the common notion of an inverse relationship between inflation and the unemployment rate.
The theory behind the Phillips Curve: as labor becomes scarcer employers bid up wages, which are passed through to consumers in the form of higher prices.
This discussion is relevant at present because to the extent the Fed believes the Phillips Curve exists, today’s record low unemployment rate might push them to head off higher inflation with more aggressive monetary tightening.
33
InflationPhillips curve – unemployment vs. inflation
This chart illustrates the historic relationship between inflation and the unemployment rate. The correlation coefficient is +0.29, suggesting a positive, not inverse, relationship.
The Fed is grappling with NAIRU (or u*). What is the non-accelerating inflation rate of unemployment? Estimates have been much higher than 3.7%, yet inflation remains very low.
Source: NBER, BLS, Federal Reserve Bank of St. Louis. Unemployment data through August 2019; core PCED data through July 2019.
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34 Source: Federal Reserve. Monthly data through August 2019. 1.63% 10-year Treasury yield minus 0.04% 10-year TIPS yield.
InflationInflation expectations have been declining for 15 years
The difference between the nominal 10-year Treasury bond yield and the TIPS yield gives the market’s opinion for a 10-year inflation forecast.
It has turned down.
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InflationPCED – headline and core
Source: NBER, Federal Reserve Bank of St. Louis. Data through July 2019.
Inflation at +1.4% is running way below the Fed’s latest forecast.
Meyer: Let me shift gears and talk about inflation for just a second. Hold on. Let me look at my clock and see how much time we have left. Twenty minutes left. That’s about right. OK, one of the other observations I wanted to make, about how the Fed is continuously pushing on a string here and I think their policy actually is quite misguided. The Fed keeps thinking they can stimulate the U.S. economy with monetary policy, and I think it’s preposterous for them to think this because there is no way to stimulate the U.S. economy with monetary policy. They’ve already taken interest rates so low that nobody’s short for credit, and I just don’t understand what they’re trying to accomplish. Inflation, here, as you can see, has actually been running a consistent 1 and a half percent. And yet the Fed persists in these inflation targets and forecasts 2 percent. They keep thinking they can stimulate inflation with easier monetary policy, which, again, I think is preposterous. And the reason I say they can’t stimulate the U.S. economy with monetary policy is because the economy is already running at its max potential. Potential GDP growth is a function of growth in the labor force plus productivity gains, both of which are maxing out right now. You can’t grow the labor force any faster than we’re currently growing it. We’re bumping up against hard limits. And productivity gains have actually been surging recently, probably can’t go any higher. So I think it’s ridiculous.
36
InflationInflation has been trending at +1.5% for years
Source: U.S. Commerce Department reported by Federal Reserve Bank of St. Louis. Data through July 2019. 1 CAGR = compound annual growth rate.
Inflation has been running way below the Fed’s 2% forecast and 2% target.
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Presenter
Presentation Notes
Meyer: But nonetheless, they persist. And what they’re going to do, then, is follow in the [laughs] tracks of the European Central Bank, headed for lower and lower interest rates and bond yields, I think. At the same time, inflation expectations, again, it’s almost comic how inflation expectations have been headed lower for 15 years. Measured inflation expectations. And yet the Fed keeps thinking, “Well, you know, we can goose inflation expectations and get actual inflation back up towards 2 percent any time now with monetary policy.” I think it’s ridiculous. We’re in a globally disinflationary world.
37
InflationCPI from 1800
Source: For 1800 though 1970: FRBSL, Historical Statistics of the United States, Colonial Times to 1970, U.S. Department of Commerce. Page 197. For 1970 through 2018: FRBSL.
38 Source: Bureau of Labor Statistics and BEA. ECI quarterly data through June 2019. Core PCED monthly data through July 2019.1 Employment Cost Index. The BLS ‘s ECI is built with fixed weights for individual industries and occupations.
Core inflation has remained flat despite wage and benefit inflation picking up.
Because wages, salaries and benefits are companies’ biggest single cost, they are also presumed to be the biggest single inflation factor for the economy as a whole.
Inflation (core PCE deflator) generally runs lower than measured ECI inflation because higher employment costs can be offset by productivity gains.
InflationEmployment cost index and inflation
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Presenter
Presentation Notes
Meyer: Now, on the other hand, employment cost inflation is trending higher, which is a very good thing from the standpoint of growth in wages and spendable income, which is driving the U.S. economy. But the core PCE deflator you see here is persistently stuck below 2 percent. How do you account for that? If wages are the single biggest cost item for most companies, how can rising wage and benefit inflation, at 2.7 percent, result in headline inflation stuck below 2 percent?
39 Source: Bureau of Labor Statistics, quarterly data through June 2019.
Productivity gains have averaged +1.2% per year for the last five years, much lower than the historic average, but the trend is improving.
Productivity gains partially offset wage gains.
InflationProductivity – Q1-Q2 surge
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e fr
om p
revi
ous q
uart
er a
t ann
ual r
ate
(%)
Productivity
5-year moving average
Presenter
Presentation Notes
Meyer: And the answer is extraordinary productivity, which we’ve just been seeing in spades in the last two quarters. This is really a positive development. And the reason the numbers work that way is companies can offset rising wages and benefits with higher productivity, and so they don’t have to pass along cost hikes in the form of higher prices.
40 Source: The Wall Street Journal, May 9, 2019.
InflationInternet-enabled supply-side shock
41
Point of ViewSeptember 2019
Global demographics➢ U.S. “echo boom” to drive a recovery in working age
population growth➢ U.S. working-age population forecasts are favorable
compared to other major economies➢ immigration accounts for 48% of U.S. population
growth➢ global population bust➢ working-age population in Europe, Japan and China
is already in decline
Presenter
Presentation Notes
Meyer: OK, let me go back to global demographics because, again, this is the big story this month. And I think this is just a really big story all the way around. You hear people talk about global demographics but I don’t think we’ve seen anything yet in terms of people really internalizing and appreciating what’s going on here, particularly as it relates to bond yields. In this first slide, let me first address the U.S. population forecast and then I’ll get to Rest of World.
42 Source: U.S. Center for Health Statistics, annual data through 2017.
GDP growth potential = ∆ productivity + ∆ labor forceU.S. live birth profile
Presenter
Presentation Notes
Meyer: You’ve seen this chart before, but this is live births in the United States going back to 1909. So over 100 years of live birth statistics in the United States. And this baby boom generation’s probably the most highly publicized demographic event in all of world history. How many people made their fame and fortune writing all about this? Start with Harry Dent and others. But what’s important today is not that. It’s this: The echo boom generation. Already 50 million more than the baby boomers. Hasn’t collapsed. It’s slowed down, but it’s not collapsing. OK, so here’s the point. The peak birth years for my generation were 1957 to 1961.
43
GDP growth potential = ∆ productivity + ∆ labor forceU.S. working age population forecast
The U.S.’s prime working age population growth is set to slow to a crawl through 2029.
Thereafter, beginning in 2030, growth picks up to a trend rate of +0.43% CAGR.
Source: World Bank, 2019. Data through 2017.
180
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Mill
ions
Population Ages 15-64
U.S. boomers’ peak retirement years
2022-26
actual forecast
Presenter
Presentation Notes
Meyer: Add 65 working years to those birth years and you get peak retirement years, here. So in this slide you’re looking at the World Bank’s long-term forecast for the working-age population for the United States. And you can see that in and around these peak retirement years, then, our working-age population growth slows down markedly. Back to Slide 52: U.S. Live Birth Profile Meyer: Going back to this slide, what’s happening is the number of retirees is fast increasing as we approach the peak retirement years of 2022. But then on the back side of this, then, the number of retirees starts slowing down, being more than replaced by the echo boom generation. Back to Slide 53: U.S. Working Age Population Forecast Meyer: So the bottom line is what you see in this chart. At about 10 years from now, then, our working-age population starts reaccelerating, and that’s the important takeaway from this chart. About 10 years from now, the United States’ working-age population starts to reaccelerate, which will be good news for GDP growth because, as I said earlier, the equation to keep your eye on is GDP growth potential is the sum of growth in labor force and productivity gain. So our profile long-term looks pretty darned attractive.
44
“We do not face the challenge of a population bomb but a population bust—a relentless, generation-after-generation culling of the human herd.”
Almost every country in Europe now has a fertility rate below the 2.1 births per woman that is needed to maintain a static population. … That trend is well under way in Japan, whose population has already crested, and in Russia, where the same trends, plus high mortality rates for men, have led to a decline in the population.
What is striking is that the population bust is going global almost as quickly as the population boom did in the twentieth century.
Fertility rates in China and India, which together account for nearly 40 percent of the world’s people, are now at or below replacement levels. So, too, are fertility rates in other populous countries, such as Brazil, Malaysia, Mexico, and Thailand. Sub-Saharan Africa remains an outlier in terms of demographics, as do some countries in the Middle East and South Asia, such as Pakistan, but in those places, as well, it is only a matter of time before they catch up, given that more women are becoming educated, more children are surviving their early years, and more people are moving to cities.
DemographicsGlobal population bust
Source: Foreign Affairs, September/October 2019.
Presenter
Presentation Notes
Meyer: Now let’s talk about global population projections. In this top panel, this is world population, expected to peak about 80 years from now. I know this is big-picture thinking and all that, but nonetheless, this is the world estimated population. We peak out 80 years from now in world population at 11 billion people. This is the United States’ population projection. Similar steady increase in U.S. population, although the rate of increase slows slowly. Now contrast that with Japan’s population is already shrinking. The whole population is already shrinking. Europe about five years from now is expected to experience its first population decline, and so is China about 10 years from now.
45 Source: United Nations, illustrated by Yardeni Research, Inc., with permission.
Dem
ogra
phic
sW
orld
pop
ulat
ion
fore
cast
s
U.S. population is forecast to grow while the populations of the world’s other major economies are forecast to decline.
Presenter
Presentation Notes
Meyer: Total population will start shrinking in those places. Now let’s look at what’s really important. The working-age population in Europe is already collapsing. Not collapsing, but it’s dramatically shrinking. Germany’s working-age population, the engine of economic growth for the EU, is shrinking. Japan’s working-age population is already in decline, and China’s working-age population is already in decline, and that will speed up dramatically. Contrast that against the United States’ long-term working-age population forecast down below.
46
GD
P gr
owth
pot
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l = ∆
pro
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ivity
+ ∆
labo
r for
ce
Wor
king
-age
pop
ulat
ion
fore
cast
s
U.S. demographics are favorable for long-term economic growth in contrast to the world’s other major economies.
China
Source: United Nations, illustrated by Yardeni Research, Inc., with permission.
Presenter
Presentation Notes
Meyer: The punch line here, then, is that if you look at these forecasts for working-age population long-term, the United States has by far and away the most positive demographic profile, from an economic growth standpoint, of any of the major economies. Some of you have heard me before talk about my predilection for not putting one dollar invested in the EAFE. In other words, foreign developed markets index. Europe, Australia, Far East. Why? Because what does Far East stand for? That’s Japan. Twenty-six percent of the EAFE is Japan.
47 Source: World Bank, 2019. Data through 2017. Euro area includes the 19 countries that use the Euro currency, including Germany, France, Italy and Spain.
GDP growth potential = ∆ productivity + ∆ labor force Working age population forecasts
The U.S. has favorable long-term demographic prospects compared to the world’s major economies.
The baby boom peaked in 1957-61. Which means that the boomers’ peak retirement years will be 2022-2026.
Thereafter, growth in the working age population picks up.
0
63
125
188
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0
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700
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2049
Mill
ions
Mill
ions
Population Ages 15-64
China (left axis) Euro area (right axis) Japan (right axis) United States (right axis) Russia (right axis)
actual forecast
48 Source: World Bank, 2019. Data through 2017. Euro area includes the 19 countries that use the Euro currency, including Germany, France, Italy and Spain.
DemographicsAge dependency ratio
The U.S.’s long-term prospects are better than most.
20.
40.
60.
80.
100.
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depe
nden
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tio (%
)
Age dependency ratio(non-working-age population as a percent of working-age population)
actual forecast
Presenter
Presentation Notes
Meyer: And Japan’s market has actually, over the last 25 years, lost money. You’ve lost money point-to-point over the last 25 years in 25 percent of the EAFE Index. Why on Earth would you want to own foreign developed markets? But back to this demographic story. Again, this ties right back into my earlier statements about bond yields, both foreign and ultimately feeding back into the United States. This story I think is something we’re right on the cusp of really starting to appreciate. This article in Foreign Affairs, very prestigious Foreign Affairs magazine, currently published, September/October publication date. “We do not face the challenge of a population bomb but a population bust — a relentless, generation-after-generation culling of the human herd.” Wow, pretty strong statement. Fertility rates in China and India, which together account for nearly 40 percent of the world’s people, are now at or below replacement levels. And what they say is, yes, these other places, like Brazil, Malaysia, Mexico, and Thailand, that still have higher fertility rates will all come around eventually to lower than replacement fertility rates. Which, by the way, is why I think those global population forecasts going out 80 years, I think, are suspect. I think this possibly happens sooner rather than later. But the really important thing to understand is what matters, from an investing standpoint, is what’s going to happen in Europe, Japan, and China, because those are the world’s major economies by far. And it’s not good. And it also bodes towards a global savings glut chasing a diminishing supply of sovereign debt in the case of Europe.
49
Economy+2.3% Q2 y/y GDP growth right on the 10-year post-recession trend
slowing growth due to weakening manufacturing and exportsstrength in consumer and government spending
➢ consumers are in record-strong shape: strong jobs growth, wage gains, job openings, real DPI, household balance sheets, savings rate, financial obligations ratio, consumer sentiment, booming retail sales
➢ strong small business optimism index➢ upticks in the LEI and non-manufacturing PMI ➢ declining inflation expectations
Point of ViewSeptember 2019
50
TradeHeadline hype
Source: MarketWatch, August 12, 2019.
Presenter
Presentation Notes
Meyer: OK, just a couple of highlights on the U.S. economy. The first is going back to this question of the trade wars and what do they mean for the United States economy. My first observation is how overblown that whole topic has become by the media. I think I showed you this same slide last month, but to me it’s just so emblematic of how the press has been treating this topic. “When the Unthinkable Happens: U.S.-China Trade Negotiations Break Down for Good.” Well, for goodness’ sake, that sounds like nuclear armageddon, “When the unthinkable happens.” [laughs] And “the Federal Reserve wouldn’t be able to save the economy,” and yada yada yada.
51
The U.S. economy is running at its full calculated potential, according to the CBO.
Since the 1950s, U.S. GDP growth has been gradually slowing, principally due to slower population growth and declining labor force participation.
The Congressional Budget Office forecasts an average of < +2.0% annual GDP growth through 2029.
+2.3% GDP growth forecast for 2019 despite the inverted yield curve and China tariffs.1
Sources: BEA, CBO. Actual annual data through 2018; and CBO forecast through 2029 dated August 2019 from the CBO’s report An Update to The Budget and Economic Outlook: 2019 to 2029. 1Actual tariffs in effect as of July 25, 2019, the date CBO completed this set of forecasts.
Economic growth
GDP growth potential = ∆ productivity + ∆ labor force
Meyer: Let me tell you, the Congressional Budget Office released just two weeks ago its latest 10-year GDP forecast, and they explicitly said in the underlying assumptions that they factored in the tariffs as they currently exist in these economic projections. And they still came up with 2.3 percent GDP growth for 2019. That’s this year. That’s among the higher economic growth forecasts for 2019, and they explicitly have factored in the tariffs as they currently exist. So again, my point here is this story is being grossly overblown. My own opinion is you could do no business with China and the U.S. economy would be fine because it means so little in the end for the U.S. economy. Yes, a lot of dislocations, a lot of changes would have to be made. Supply chains and so forth. Find a new home for U.S. soybeans and corn and so forth. But in the end, in the macro, the macro effect of tariffs with China, I think, are being grossly overblown by the media.
52
Economic dataSmall business optimism index – strong
Source: NFIB. June data released September 10, 2019.
This index started fading well before the onset of recession in 2008.
Presenter
Presentation Notes
Meyer: OK, the second data point was released this morning. And again, you’ve heard me say this before but the Small Business Optimism Index, in my mind, is a very important signal from the U.S. economy. Why? Because small businesses employ 50 percent of all Americans and accounted for between 60 and 80 percent of all new hires over the last decade. So this is what was released this morning, and I love their headline. I just thought it was so interesting. “Small Business Economy Remains Steady, Despite Doom and Gloom Narrative That’s Hampering Expectations.” Wow. So even the NFIB is commenting on, again, my notion that perception created by the media, whipping up pessimism and concern over the economic forecast, is not what small business owners are seeing. But on the other hand, it can affect psychology negatively. But anyway, historically a very solid reading. See, we’re still at almost a record all-time high, just off the record all-time high in this index. And interestingly, down below, “Credit conditions are about as supportive as they have ever been in the 46-year survey history.” Now, what’s important about that is that the theory behind an inverted yield curve is that when banks’ cost of funds, on the short end of the curve, exceed what they can earn on loans, then they stop making loans. That’s the theory behind the yield curve. But in fact, that’s not playing out at all in this current episode. Credit remains ample. And that’s the key to the economy, regardless of the shape of the curve. At least it seems to me.
Economic dataU.S. index of leading economic indicators – uptick
Up +0.5% in July following -0.3% in June.
“The US LEI increased in July, following back-to-back modest declines … While the LEI suggests the US economy will continue to expand in the second half of 2019, it is likely to do so at a moderate pace.”
This chart shows how the LEI has definitively rolled over well in advance of the last two recessions.
Shaded bands represent recession.
Presenter
Presentation Notes
Meyer: OK, the index of leading economic indicators also up in July, following three consecutive downticks. And so I thought that was pretty interesting. A forward look on the LEI has resumed its uptick. The “LEI increased in July, following back-to-back … declines … suggests the U.S. economy will continue to expand in the second half of 2019.” So, what about David Rosenberg? “We’ll be in recession by the end of the year.” This one is not suggesting that view will turn out to be the correct one.
54Source: Copyright 2019, Institute for Supply Management. Data through July 2019.ISM: “A reading above 50 percent indicates that the manufacturing economy is generally expanding; below 50 percent indicates that it is generallycontracting. A PMI in excess of 43.1 percent, over a period of time, generally indicates an expansion of the overall economy.”
August ticked down to 49.1, from 51.2 in July and 51.7 in June.
August’s new orders ticked down to 47.2, from July’s 50.8, suggesting further weakness in the manufacturing PMI ahead.
Note the historic volatility in the manufacturing PMI.
Note how this indicator has slumped well below 50 even during periods of strong economic expansion, eg. 1995, 1999, 2003, 2013.
55 Source: Copyright 2019, Institute for Supply Management; data through August 2019. This data series was created in 2008. ISM: “A reading above 50 percent indicates that the non-manufacturing economy is generally expanding; below 50 percent indicates that it is generally contracting.”
August posted a nice recovery hop to 56.4 from July’s 53.7.
August’s new orders at 60.3 was a strong reading, up from July’s 54.1, suggesting strength in non-manufacturing ahead.
Non-manufacturing captures the vast majority of the U.S. economy.
35
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Presenter
Presentation Notes
Meyer: This is an interesting one, the non-manufacturing. First of all, the manufacturing PMI went below 50. But what’s important, I think, is not that one. That’s, again, a small sliver of the U.S. economy. The non-manufacturing actually took a pretty nice hop after trending down in June and July, a hop to 56.4. And in absolute terms, this is a pretty darn strong reading at 56. Non-manufacturing captures most of the U.S. economy.
56
Economic data – consumer spendingReal disposable personal income per capita
Source: Bureau of Economic Analysis, data through July 2019. CAGR means compound annual growth rate.
Real DPI per capita up +2.4% y/y in July, from +2.7% y/y in June.
27,000
32,000
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Real
DPI
per
cap
ita (c
hain
ed (2
009)
dol
lars
) ($)
Real DPI per capita7/02-7/07
+1.8% CAGR1
Real DPI per capita+2.4% y/y
Presenter
Presentation Notes
Meyer: Real disposable personal income per capita ripping along at 2.4 percent year-over-year. I say that, ripping. How can you say 2.4 is ripping? Well, it’s ripping by comparison to the 5-year compound annual growth rate of just 1.8 percent prior to the last recession. This is real — that means adjusted for inflation — after-tax per capita — divide by the total number of Americans. Income growth is really strong in this economy.
57
Economic data Real retail sales – good gains
Real retail sales ex-gasoline up +1.6%% y/y, recovered from abrupt December drop.
Source: U.S. Census Bureau, BEA. Data through June 2019.
340,000
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onth
ly)
Shaded band represents recession.
Presenter
Presentation Notes
Meyer: Which is driving ripping retail sales, which is what you see here. And that’s why I showed you those stock price charts for Walmart, Home Depot, and so forth.
58 Source: Bureau of Economic Analysis, quarterly data through June 2019.
Economic data Contributions to GDP growth: C + I + G + Net Exports
Meyer: So these are the four cylinders of the U.S. economy: consumption, investment, government spending, and net exports. And what you see is this extraordinary strength in personal consumption expenditures contributing 3.1 percent of a total of just 2.0 percent second quarter GDP growth. So the big takeaway was investment that is related to negative perceptions on the trade war and manufacturing, and also net exports. But interestingly, consumption, and interestingly, government spending has also been contributing. But the major point takeaway here is, look, four cylinders aren’t created equal. This is 70 percent of the U.S. economy, and that’s what I think will carry us through weakness in manufacturing being contributed to by negative trade rhetoric and so forth. But personal spending will probably remain strong.
59 Sources: Bureau of Economic Analysis, actual quarterly data through June 2019. The Wall Street Journal survey taken August 2019.
Consensus GDP forecastNo recession in the forecast
Despite the inverted yield curve and trade war …
… the 60 economists surveyed in early August see an average +1.8% rate of quarterly GDP growth over the five quarters ahead.
Meyer: So again, if you say, well, so what do the smart guys in the economics forecasting business actually conclude, the answer is summarized in this chart. This is The Wall Street Journal’s monthly survey of the 60 economists, the best and brightest economists that they’ve identified, and you can see, again, just like the CBO, they suggest that 1.8 percent on average, looking out the next five quarters. So they too are not seeing recession in the forecast.
60
Jobs➢ full-employment ➢ surprising continued strength in new jobs➢ record job openings➢ declining participation rate due to ageing ➢ Still some slack?➢ strong relative U.S. job formation forecast long-term ➢ strong real wage and income growth➢ mean and median incomes bottomed
Point of ViewSeptember 2019
Presenter
Presentation Notes
Meyer: I should point out that historically economists haven’t seen big turns coming. You can’t rely on these forecasts as being the gospel. But, again, you got to start somewhere in analyzing the forward-looking economic data, and this is the best that the economists can do. And that’s their summary.
61
Economic data - jobsNet new job formation and the unemployment rate
Source: Bureau of Labor Statistics. Data through August 2019.
130,000 net new jobs in August.
Job formation slumped dramatically preceding the last two recessions.
3.7% unemployment rate is near the December 1969 record low.
Accounting for population growth, 95,000 new jobs per month are required to maintain a stable unemployment rate.
0.
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Presenter
Presentation Notes
Meyer: A couple interesting job statistics, 130,000 net new jobs created in the month of August. That’s pretty much in line with the historic post recession average. If you take six months’ averages, it’s trending down a little bit, but nonetheless a still strong number, recognizing that it takes 95,000 net new jobs just to hold the unemployment rate level because 95,000 is keeping up with population growth. So at 130,000, we’re still creating new jobs at a clip that’s faster than the organic growth in the number of people available to work.
62
Economic data - jobsNet new job formation – household vs. establishment surveys
Source: Bureau of Labor Statistics. Data through August 2019.
August’s blowout household survey.
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The household survey includes agricultural workers, self-employed workers whose businesses are unincorporated, unpaid family workers, and private household workers among the employed. These groups are excluded from the establishment survey.
Presenter
Presentation Notes
Meyer: Now, here’s a real anomaly that I wanted to call your attention to. The government BLS does two job surveys every month, the household survey and the establishment survey —130,000 on the establishment, and [laughs] I don’t know what to make of 590,000 on the household survey [laughs]. But it’s really not consistent with the notion of slowing in net new job formation. It’s just amazing number.
63
Economic data - jobsNet new job formation – BLS and ADP surveys
Source: Bureau of Labor Statistics and ADP Corporation. Data through August 2019.
August’s ADP private sector jobs survey exceeded the BLS survey.
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Presenter
Presentation Notes
Meyer: OK, so let me talk about the federal debt and deficit. First of all, let me check to see how much time I have left. This’ll take about five minutes, but this is the last point I wanted to make. So I’ve got three minutes left to hit one hour. I’ll see if I can do this in three minutes, just for grins. What’s good about what I’m going to talk about is this data is hot off the press. It was just released by the Congressional Budget Office. It’s called the August Update to the Congressional Budget Office’s January Set of Forecasts for Federal Spending and Federal Debt.
64Source: BLS, BEA. AHE data through August 2019. Inflation data through July 2019. 1AHE includes 100% of non-farm private employees, and excludes benefits and employers’ share of payroll taxes. 2 Compound annual growth rate March 2006 through December 2008 = 3.4%; CAGR December 2008 through July 2019 = 2.15%. 2 March 2006 average hourly earnings of $20.04 inflated by the personal consumption expenditures deflator (PCED).
WagesAverage hourly earnings vs. inflation
+3.2% in August, from +3.3 in July, from +3.2% y/y in June.
AHE have accelerated from the 10-year post-recession trend rate of +2.2%.
AHE growth has outstripped inflation, black line.
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Federal budget➢ CBO’s June and August 2019 updated projections➢ increasing deficits, rising debt➢ Could we fix it?➢ low U.S. tax burden allows flexibility to solve long-
term entitlements problem
DebtFederal government debt
Presenter
Presentation Notes
Meyer: OK, so let me talk about the federal debt and deficit. First of all, let me check to see how much time I have left. This’ll take about five minutes, but this is the last point I wanted to make. So I’ve got three minutes left to hit one hour. I’ll see if I can do this in three minutes, just for grins. What’s good about what I’m going to talk about is this data is hot off the press. It was just released by the Congressional Budget Office. It’s called the August Update to the Congressional Budget Office’s January Set of Forecasts for Federal Spending and Federal Debt.
66
Individuals, 16%
Federal Reserve, 15%
Mutual Funds, 12%
Financial Institutions, 6%Pension Funds, 6%
State & Local Gov't, 4%
China, 8%
Japan, 7%
Next Eight Largest, 12%
All other nations, 14%
Federal deficit and debtHolders of Treasury Debt
Source: Congressional Budget Office, The Budget and Economic Outlook: 2018 to 2028, released April 2018; and The Budget and Economic Outlook: 2019 to 2029, released January 2019.
Foreign holders(40%)
Domestic holders(60%)
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Social Security
Other Federal Noninterest Spending
Federal deficit and debtFederal debt % of GDP through 2049
Source: Congressional Budget Office, The 2019 Long-Term Budget Outlook, released June 2019. The extended baseline generally reflects current law, following CBO’s 10-year baseline budget projections through 2029 and then extending most of the concepts underlying those baseline projections for the rest of the long-term period through 2049.
Meyer: This is the chart that we’re all worried about, and this didn’t come from this update. This is the long-term set of projections that they do every year, released June of this year. And this is a set of forecasts that takes you all the way out through 2050, so it’s a 30-year forecast. And the problem here is that debt as a percent of GDP soars into the stratosphere if we keep incurring deficits at the current clip. So this is the issue that we need to deal with.
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Federal deficit and debtFederal outlays % of GDP
Source: Congressional Budget Office, An Update to the Budget and Economic Outlook: 2019 to 2029, released August 2019. Major health care programs consists of outlays for Medicare (net of premiums and other offsetting receipts), Medicaid, and the Children’s Health Insurance Program, as well as outlays to subsidize health insurance purchased through the marketplaces established under the Affordable Care Act and related spending. CBO’s interest rate forecasts have the fed funds rate rising gradually to 2.7% by 2029 and the 10-year Treasury bond yield rising to 3.2% by 2029.
Man
dato
ry o
utla
ysDi
scre
tiona
ry
outla
ys
0.0
7.5
15.0
22.5
30.0
1969 1994 2019 2029
Out
lays
as a
per
cent
of G
DP (%
)
Social Security
Major Health Programs
Net Interest
Other
Nondefense
Defense
Actual Projected
Presenter
Presentation Notes
Meyer: And this is what scares people when they see that chart. First question is, well, where’s this spending coming from? And I think it’s no secret to any of you. The spending is coming from increasing allocations forecast to continue increases in spending on Social Security, Medicare, and Medicaid. You can see that the biggest growth is in those so-called entitlement programs. Defense actually gets squeezed a little bit as a percent of GDP. And the problem of course is that to the extent that the stock of debt continues to increase, then the net interest burden also continues to increase as a percent of GDP over time. What you’re looking at here, bottom line, is ten years forecasted of spending by category.
69
Medicare and Medicaid
Other Federal Noninterest Spending
Federal deficit and debtFederal revenues and outlays – budget deficit equal to 4.0% of GDP
Source: Congressional Budget Office, Update to the Budget and Economic Outlook: 2019 to 2029, released August 2019.
In 2018 federal spending outstripped revenues by an amount equal to 4.0% of GDP per year.
12.0
16.0
20.0
24.0
28.0
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
Perc
ent o
f GDP
(%)
Average revenues 1969 to 2018
Average outlays 1969 to 2018
actual projected
Presenter
Presentation Notes
Meyer: So now let’s look at this latest update — as I say, hot off the press from the CBO — of total spending as a percent of GDP compared to total revenues as a percent of GDP. So today, the issue is the 4 percent gap, as a percent of GDP, between spending and revenues. Remember the 4 percent number. Four percent is the gap between spending and revenue today. And the issue is how do we close that gap to some degree, and how much do we need to close it to solve the problem. You see, you don’t have to balance the budget. If your goal was to balance the budget, then your goal would be to eliminate debt outstanding. That doesn’t make sense. Any government, any company, has an optimal amount of debt outstanding. You do that to maximize your resources, your assets. So we don’t want to eliminate the federal debt. We just want to hold it constant as a percent of GDP, whereas it’s forecast to go from 78 percent to 150 percent. That’s not good.
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Medicare and Medicaid
Other Federal Noninterest Spending
Federal deficit and debtFederal deficit – equal to 4.0% of GDP
The deficit is projected to rise from 4.1% of GDP in 2018 (actual) to 4.8% of GDP in 2029.
-10.0
-6.8
-3.5
-0.3
3.0
6.3
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
Defic
it (s
urpl
us) p
erce
nt o
f GDP
(%)
Source: Congressional Budget Office, Update to the Budget and Economic Outlook: 2019 to 2029, released August 2019.
actual projected
Average deficit 1969 to 2018 = 2.9%
Presenter
Presentation Notes
Meyer: So from the previous slide we can calculate this, the deficit as a percent of GDP. Income minus spending results in 4 percent today, increasing to 4.8 percent of GDP looking out ten years. This is the latest set of forecasts. By the way, they base their forecasts on current law. Current law. That’s what they are tasked to do, and they do that so that Congress can have a baseline set of numbers from which they conclude, “Well, if we don’t do anything, under current law this is what’s likely to happen.” So that’s the way that works. So again, 4 percent gap between income and spending today.
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Medicare and Medicaid
Other Federal Noninterest Spending
Federal deficit and debtWhat level of deficits would it take to hold debt constant?
Budget deficits of 2.9% of GDP would result in no increase in debt as a % of GDP.
0
25
50
75
100
1969
1971
1973
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
2017
2019
2021
2023
2025
2027
2029
Fede
ral d
ebt h
eld
by th
e pu
blic
% o
f GDP
(%)
Source: Congressional Budget Office, Update to the Budget and Economic Outlook: 2019 to 2029, released August 2019.
actual projected
Presenter
Presentation Notes
Meyer: Now, this is the most important chart on this topic that I can give you. The question we’re asking here is, well, what level of deficits would it take to hold debt constant? In other words, with deficits at 4 percent increasing to 4.8 percent, then the debt goes from 78 percent, in this chart, to 95 percent looking out ten years. Looking out 30 years, it goes to 150 percent. But my question for you is, well, OK, so what would it take to simply hold debt as a percent of GDP constant? Solving for that variable, the answer is 2.9 percent, OK? Back to Slide 79: Federal Revenues and Outlays — Budget Deficit Equal to 4.0% of GDP Meyer: So back to this chart. The point I wanted to make is — back to this chart — if the current gap is 4 percentage points between spending and revenue and you need to get it to 2.9 percent, then you’re only talking about having to close this gap by 1.1 percentage points. One point one percentage points, either in the form of cut spending, raising revenues, or a combination of both. Back to Slide 81: What Level of Deficits Would It Take to Hold Debt Constant? Meyer: Now, that’s the key takeaway that I wanted to leave you with. Budget deficits of 2.9 percent of GDP would result in no increase in debt as a percentage of GDP. Does that seem like a tall order or an impossible ask? My answer to that question is, “Absolutely not.”
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Medicare and Medicaid
Other Federal Noninterest Spending
Federal deficit and debtDebt-to-GDP comparisons
Source: IMF. Actual data through 2017.
0.
40.
80.
120.
160.
200.
France Germany Italy Japan United Kingdom United States
Gove
rnm
ent n
et d
ebt p
erce
nt o
f GDP
(%)
2015 2016 2017 2018(E)
Presenter
Presentation Notes
Meyer: We could solve this problem overnight, it seems to me, to the extent we had the political will to do it. The problem is precisely that. Congress and the president has realized that telling Americans they’re going to have cuts to their entitlement programs is a non-starter. So probably the answer is you got to figure out how to raise revenues by only 1 percent of GDP.
73 Source: OECD Revenue Statistics 2018, published December 5, 2018. Data for 2017.
Medicare and Medicaid
Social Security
The U.S. has a much lower total tax burden and takes a very different approach to raising tax revenues compared to most other developed economies.
TaxesTax structure U.S. vs. Germany
2.1%
3.1%
0.
12.5
25.
37.5
50.
U.S. Germany France
Tax
reve
nue
perc
ent o
f GDP
(%)
Social security and other payroll contributions
Taxes on income and profits
Taxes on property
Taxes on goods and services including
VAT
27.1%
37.5%
46.2%Other
Presenter
Presentation Notes
Meyer: Only 1 percent of GDP. One point one percent, actually, according to that number that I solved for. So now let me ask you, based on this set of statistics, do you think that’s a tough ask? I say, “No, it’s easy.” The total tax burden in the United States is 27.1 percent of GDP. This is federal, state, local taxes, real estate taxes, inheritance taxes, excise taxes, everything. In Germany, it’s 37 and a half percent. In France, it’s 46.2 percent.
74Source: OECD, Revenue Statistics 2018. 2017 data for all countries except 2016 data for Australia and Japan. Includes data for the 36 OECD countries and does not include non-OECD countries such as China, Brazil, India and Russia. Includes all forms of taxes: federal, state and local; income taxes, sales taxes, VAT taxes, estate taxes, property taxes, etc.
Medicare and Medicaid
Social Security
Other Federal Noninterest Spending
The U.S.’s comparatively low tax burden allows flexibility in solving its long-term entitlement spending problem.
TaxesTaxes % of GDP – U.S. is the lowest of major developed
Meyer: The United States has by far and away the lowest total tax burden of any of the developed economies. Which, by the way, in my mind, is one of the reasons the United States has been such a terrific economic performer by comparison. We leave more money in the hands of businesses, with which they can invest and create new jobs. So low taxes is good. Back to Slide 83: Tax Structure U.S. Vs. Germany Meyer: But if the question is, “OK, but if Americans don’t want to give up their spending, could we raise taxes reasonably to solve this problem?” And my answer is, “Yeah, and we could probably do it without even feeling it.” Raising taxes from 27.1 to 28.2 percent, which theoretically would do the job, then, to me, is a no-brainer. And as I say, I think you could probably do it with no sweat. You wouldn’t feel it, compared to the economies of Germany and France in this analysis.
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Investment Strategy S&P 2019 YTD sector returns vs. the strategists1 calls
Source: Standard and Poor’s1 From Barron’s survey of 10 Wall Street strategists, published December 17, 2018.
Most favored
Neutral
Favored
Not favored
Not favored
Favored
Favored
Favored
Least favored
Least favored
Most favored
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30
Technology
Real Estate
mer Discretionary
unication Services
Consumer Staples
Industrials
S&P 500
Utilities
Financials
Materials
Health Care
Energy
S&P Sector Performance 9-7-19 YTD (%)
Presenter
Presentation Notes
Meyer: Before I leave, just because I love this analysis, just changing gears entirely here, changing subjects entirely. You all, I think, are familiar with my notion that following advice from Wall Street experts about tactical asset allocation is a sure way to lose money, and definitely a way to give alpha away, to lose alpha, not add alpha, for your clients. So I just wanted to update you on the forecasts made by the 10 strategists surveyed by Barron’s in December of last year as to what sectors were going to be the best and worst this year in 2019. You can see that they got technology right. Their most favored sectors were technology and health care, and they got tech right. OK, kudos for the strategists on that. Except that equally favored to technology was health care, which is second-to-last place. Then the most hated sectors among that group of 10, the highest ranking strategists in Wall Street, are in second and third place. Mind you, they hated these sectors coming into this year. “Hated” sounds like a strong word, but they panned these sectors more frequently than any other sectors, and they are in second and third place. Then, by the same token, the stuff they liked generally all is trailing the S&P 500. So there you go. That’s the wisdom of following the so-called smart money in Wall Street. Don’t do it. My advice to you is stick with modern portfolio theory, stay fully invested, periodically rebalance, and you’re going to do just fine. Q&A Start Meyer: OK, I think I’m a few minutes over. I apologize for that. I certainly did everything I wanted to do. And, Andy, if we have time for questions, I’ll be happy to take those. Gluck: If it’s OK with you. By the way, I just want to mention to everybody that that survey was done December 17th, it says at the bottom that’s when those predictions were made, and you can see the year-to-date performance. Just want to make that clear. But they got technology right. Meyer: Right. They got technology right. Gluck: [laughs] Meyer: Yeah, once in a while they get stuff right. But my point has been, look, on average they get more wrong than right, and that’s really clear from this long-term analysis that I’ve been doing now for 14 years. So the conclusion is if you think tactical asset allocation is a way to add alpha, then you’d be disappointed. And I just marvel at how the Wall Street firms, aided and abetted by CNBC, by the way, who parades these people on the air … And it’s not just them. It’s money managers, broadly speaking, who come on and they say, “Well, you know, in this part of the cycle you need to overweight this and underweight that.” And I’m saying hooey to that. First of all, there is no repeated cycle, repeating cycle. And secondly, if there were, don’t you think everyone would be wise to it? And so to get alpha in that approach to investing is a ridiculous proposition to begin with. And yet they persist in trying to sell us on the notion that their guy, their strategist, can help you. And in fact, they can’t. They systematically can’t. And furthermore, by the way, as I look at the individual performance of each of those 10, none of them individually has stood out, saying, “Yeah, well that’s generally true but there are a handful of people that can systematically add alpha with that.” Nope, there aren’t. There aren’t. And some of them got straight A last year for all of them wrong. All their calls were absolutely, precisely wrong. It’s just unbelievable. Gluck: Yeah. And I just want to mention that every six months or so we look back at that and put that in a consumer video. So we’ll be doing that again and updating that, so please look for that. Now, Fritz, if it’s OK, I know from looking at these many questions that it’s going to take you a long time to read these and answer them. Some of them are long. Can we maybe agree to talk next … We could go through the questions and I’ll record that? Meyer: Yeah, possibly. It’s just that I’m traveling pretty solid and it may be difficult. If you want to hit one or two right now, let’s do it. Otherwise, I’ll do my best. I’ll just say that. Gluck: Let’s hold off because we’re way over. Meyer: OK. Gluck: And I think we got to let everybody out of class. And so I just want to thank everybody for attending today, and thank Fritz for another amazing session. And we’ll try to get to the questions. Slide 86: Important Information Gluck: And we appreciate all your questions and thoughts here. Thanks a lot, everybody. We’ll see you next time. Thank you again, Fritz. See you later.
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All material presented is compiled from sources believed to be reliable and current, but accuracy cannotbe guaranteed. This is not to be construed as an offer to buy or sell any financial instruments andshould not be relied upon as the sole factor in an investment making decision. As with all investmentsthere are associated inherent risks. Please obtain and review all financial material carefully beforeinvesting.
The opinions expressed are those of the author, are based on current market conditions and are subjectto change without notice.
These materials may contain statements that are not purely historical in nature but are “forward-lookingstatements.” These include, among other things, projections, forecasts, estimates of income, yield orreturn or future performance targets. These forward-looking statements are based upon certainassumptions, some of which are described herein. Actual events are difficult to predict and maysubstantially differ from those assumed. All forward-looking statements included herein are based oninformation available on the date hereof and Fritz Meyer assumes no duty to update any forward-looking statement. Accordingly, there can be no assurance that estimated returns or projections can berealized, that forward-looking statements will materialize or that actual returns or results will not bematerially lower than those presented.
