Rick Unser (00:00:00):

Well, Frances, welcome to the podcast. Sometimes it's better to be lucky than good to have somebody like you to come in and talk to us about all the crazy things going on in the world when there's some stuff going on that we've quite frankly never seen, so thanks for being here.

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Frances Donald (00:00:15):

It's a pleasure and absolutely almost every day I open up my screens. Something is happening that has never happened before. It makes it a very exciting time to be an economist strategist. It also makes it a very difficult time to be an economist strategist.

 

Rick Unser (00:00:31):

I'm with you there and I guess maybe just to kick us off, one thing that that I've heard a few times and that I think people maybe have their fingers crossed about is since this was sort of a manmade shutdown of our economy as some of those restrictions or limitations are eased or removed, does that mean by as the world comes back, align, everything goes back to normal or is there maybe a different outcome that you would guide people to expect?

 

Frances Donald (00:01:04):

In some ways. That's the right way to frame it that we deliberately shot our economies. We tried to put them into hibernation to say let's just press pause and then we'll press unpause and things will go back to the way they were. The challenge, well it's two fold. The first is that our economies are not designed to be put into hibernation and as much as revenues into a lot of businesses stalled to zero costs did not. So we're going to come out the other side with fewer businesses and we're going to come out the other side with those who have been unemployed for two to three months who are in financial shock, who've experienced lower savings rates or they've piled up debt. So that has consequences that extend beyond those two to three months when we were shut down. But what really weighs on me is that while this may have been a button, we pressed to slow our economies or shut them down, the most fundamental problem facing us as we look forward is a confident shock.

 

Frances Donald (00:02:07):

Now we can turn on manufacturing plants back on and have widgets come out on the conveyor belt and we can open up the coffee shop on the corner of the street. But if people are afraid for their personal safety, if they're nervous about going out, if they're really just about spying the latte because they saw their retirement portfolio maybe hit by the financial market moves, then they're not likely to go out and spend to the same extent. So I think this experiment of putting your economy on pause will ultimately be viewed as as somewhat of a failure, but we can't do this. And if we experience pandemics in the future, whether it's a second wave to the one that we experienced this time or, or future pandemics and I hope we don't experience them. But if we do, I think you're going to have a lot of economists that tell you there should be a different approach or different types of support that should come in earlier than what we witnessed this time.

 

Rick Unser (00:03:02):

And do you have any way to gauge that comment you made there a second ago about people are potentially going to spend less, is that just from some things you've seen or heard around the circles that you're participating in or articles that you're reading or writing or is there a way that we can say, Hmm, based on this history would tell us that if people were consuming at a rate of X, it's X minus 30% or is that to try to make this too scientific?

 

Frances Donald (00:03:36):

No, we take both approaches. So most of the ways we look at the economy, actually economists, while they might seem like they're just putting their finger on the air, have very, you know, almost pseudo scientific method to come up with these conclusions. So we know and we can expect that if, let's say we lost a hundred workers that were unemployed, we're not going to have a hundred rehired on the other side. We are on our teams expecting about 80 of those 100 to come back online pretty quickly. Historically, we know it takes five times as long to re hire the amount of people who are laid off. So historically it takes about 11 months in a recession for people to lose their job. The amount of people do lose their job to finish kind of troughing off and about 50 months to rehire everybody. But we're expecting this recession to be a very condensed version of that and that's some of the reasons why the numbers look so big.

 

Frances Donald (00:04:30):

What we typically expect to happen over 11 to 12 months we think is going to happen in a period of maybe one to two months. So we're amalgamating all of those job losses into a very short period of time, but we still have this basic premise and this identity that has held throughout history, which is that if you're a small business, you let go of five people, the economy comes back online, maybe a gym maybe at a bit of an attitude problem. Maybe he was late to work sometimes. So you hire back for and you say, I'll see how it goes. If I really need Jim to come back, then I'll kind of hold my nose and bring them back online. So we're not expecting a full recovery. We're expecting a sort of purge that occurs with typical recessions. But where I'm more nervous is actually in watching the experience of some of these economies that have already come back online in China is, is our best roadmaps.

 

Frances Donald (00:05:21):

So if you took an accounting class or you took a CFA, you might've learned about the, the FIFO concept first in, first out, and this is how we're tracking the Colvin 19 crisis and its impact on the economies. So China was first into the crisis and then we're first to reopen their economy. And what we witnessed there is a, a very interesting development, which is that China reopened its economy and it told people to go back to work. China is not the United States. It's a command economy. People in some senses do what they're told. And during the week we already see that traffic activity. So people moving around in cars and buses and walking around, it's already back up to 80% what it was pre Kovats. If that sounds like it should be really great. And if we saw that in the United States, I'd feel much more enthusiastic about the so-called V-shape recovery except on weekends.

 

Frances Donald (00:06:13):

What do we see happening in China on the weekends? Traffic is still at 10 to 20% of what it was three Cove. It. This to me is the best example that you can tell people to go back to work. They will need to go back to work, but will they go back to play? Will they go out to restaurants and will they go out to movie theaters? In order to do that, they have to feel it, have full confidence that they are safe. And there's a lot of ways that you can get people to feel more confident about that. But it probably comes from medical advancements, which is outside the scope of the economists per view, but is increasingly something that we base our economic outlook on. Well really good points and I don't know that I've really heard it explained like that. And I think that makes a ton of sense and I think is another way to think about it and what I've talked to some people about, which is yeah, I don't think there's going to be this V-shaped recovery either.

 

Frances Donald (00:07:08):

I think there's too much that it has changed, but I think that's just a very easy one to point to as well, which just says safety people's patterns, they're going to change, they're going to be different and that's going to cause different consumption, different economic activities. So yeah, really well said. Well that's a great point. So when we talk about going back to normal, what does that normal look like on the other side, and I sometimes get criticized for maybe waxing too philosophical, but I genuinely witness in the data that Colvin 19 is acting as an accelerant on many structural changes that were already beginning to take hold. One of them is the concept of globalization. So this is not the first time that we've put borders up. We spent most of 2018 and 2019 applying tariffs, and this was not just an American experience, this was the UK, several emerging markets saying we want to put borders up by applying tariffs and companies were faced with the idea that supply chains could actually get disrupted.

 

Frances Donald (00:08:10):

It could cost you more money to source labor or goods or intermediary products from abroad. And then came Colvin, which is in some ways an entirely different type of shock but had the same ramification, which is borders up and supply chains disrupted. So if you're a new company and you're, let's say you want to open up a little manufacturing shop in middle America and you have to find goods and services, you might know, yes, it is more expensive for me to source those things here at home, but it's an insurance policy because I don't have to risk a future pandemic or tariffs going on. I know that I have access to my goods and labor directly at all times. That is a continuation of a trend that we were already seeing developing in the macro space. I also believe in, we witnessed this in our data, just the amount of sheer downloads of a variety of different types of communication products.

 

Frances Donald (00:09:03):

So things like zoom or Skype. We see this in real time and my suggestion will be that while the work from home trend was something that was beginning, we were forced into developing this infrastructure. So in my company for example, I had a new hire start on Monday and I went to have monitors delivered to him, his house. So he's going to have all his products brought and deliver to his front door. He started his first day in his living room working on my team, but we were out of monitors because the entire global company had set up monitors for work from home setups. And all I could think is if we had suggested this before coven 19 there would've probably been a lot of reasons why we don't want everyone in the world to have a work from home setup. But now the infrastructure is in place.

 

Frances Donald (00:09:49):

We've been forced into it. So this is very different than a lot of other seismic economic shocks we've had before. And that every single human, every single person, every single business has been impacted by this one. I also believe we're probably going to see something I'll call the fourth industrial revolution, which is a further digitalization of our economy. Even my grandmother figured out how to order something on Amazon and loves it. So we're going to have a demand for more online services. We're gonna have a demand for faster connections, better products, better ways to record podcasts like this one with even better audio quality. These are things that were already happening and part of our new normal. So as we talk about this V-shaped recovery, we probably need to look at the other side as looking maybe a little bit different than where we were even three months ago.

 

Rick Unser (00:10:40):

Yeah, and just to add onto that, your monitor story, I have a good buddy of mine that's in, let's just call it technology sales and works in the cloud side of all this, which I'm now giving you everything I know about technology. He was basically saying he had some of his clients that had 500 seats for remote access that went from 500 to 20,000 seats for people to allow them to work remotely. And yeah, I mean just big, big changes. And I've had a few conversations with clients as well that are saying, yeah, I think we're really gonna have to sit down and rethink this work from home. Because in a lot of ways this is working and this might be a better way to go about things in the future.

 

Frances Donald (00:11:23):

I also think about what kind of offshoots that creates. So you know, I live in the middle of the fourth biggest city in North America, which is actually Toronto. Very few people know Toronto is that big. I have a very small home with a toddler and my husband works from home and throughout this whole process all I could think is, Oh my goodness, we have to move to the suburbs and get a McMansion and I have to have an office. And I turned to all my other friends, millennials, small children, and they all said on the weekends we drive out 45 minutes, look at the big houses and fantasize. So as much as I'm excited about having a backyard, I also can't help but think what does this mean for urbanization processes and what does it mean for corporate real estate? If suddenly we have teams, I'm going to tell my team you want to work from home, go for it.

 

Frances Donald (00:12:15):

We've never been more productive than we have been in the last six weeks and not losing you to two hours of commute a day. You're online earlier, you leave later, you're generally happier. How do I tell a team to come back into the office five days a week? So I really wouldn't be surprised if companies as they reevaluate this, start to think about more hotel space or flex space and maybe they don't need as many floors. So as much as we think about how this impacts us on our personal level, I'm really trying to urge the teams that I work with and my clients to think about how does your individual behavioral changes that you expect to make scale to an entire economy? It's hundreds of thousands of people did what you did. How would it change the way our economy operates? And that's the thinking we have to have.

 

Rick Unser (00:12:57):

Very well said. Let me ask you one question that before we get too far away from it, I wanted to just get your thoughts on, you put out a piece a little while ago that said this recession is a little different than others in that it's a services led recession versus a manufacturing led recession. First off, did I get that right? And secondly, I guess, what does that mean and how does that factor into some of the stuff that we've been talking about?

 

Frances Donald (00:13:26):

You absolutely got it right. And thank you for reading my piece. I'm glad that that element of it resonated. So every recession that we've seen in modern economic history has been manufacturing led. And by that I mean it has mostly been men not making things, so it has been led by things like business investment or pulling back on manufacturing activity a lot like what we witnessed in 2018 2019 also, what we saw a little bit in 2016 when oil prices collapsed, what we're seeing now was initially a manufacturing shock when it was just China that was being impacted by coven 19 but what we've done by shutting salons and bookshops and coffee shops is we've targeted the part of the economy that is typically more resilient. The services side of it, the services side is a much larger part of our economy. It's also more jobs intensive.

 

Frances Donald (00:14:20):

So if you were to walk into a manufacturing plant for every, you know, $100 produced, you have far fewer people actually working in that plant than for $100 produced out of a restaurant. What that means is that if we're hammering the part of the economy that employees, most people, your job numbers are probably going to be worse than past recessions. And this is why we have those calling for double digit unemployment. That will likely be some of the worst we've seen since the great depression. Our hope is that it's short and the vast majority of people are rehired within very quick order. But the types of ways you might trade this recession, particularly on a sector base and the types of ways you might talk about a recovery have to change. And this is why I talk about confidence being so relevant is if you've known somebody who now or in the past has lost their job, it creates a level of cautiousness and concern either because they had to kind of go into their piggy banks that they had for a rainy day or they didn't have one and they racked up some debt.

 

Frances Donald (00:15:22):

So I, I hear people sometimes say, well, you know, even if we can't travel to Paris, people will take their kids domestically to Disneyland. And I think that assumes that we all come out the other side not shaken up and not having depleted any of our personal financial wealth and not having been impacted by any sort of deterioration or move in our portfolios. I think even people seeing 20% declines in inequities is going to make them feel a little less confident about what their portfolios look like as well. So it isn't an apples to apples comparison between this recession and past recessions. In some ways it will be much more painful and I think it will be harder to come out of.

 

Rick Unser (00:15:59):

And I guess on that note, a couple of things that tie into all this. When you hear recession or the possibility of recession or these kinds of economic shocks, you're in the U S that generally means the fed is going to spring to action and we've had some pretty significant interest rate cuts. We're now at, you know, basically zero to slightly above zero interest rates from a fed perspective. What do you think that means is, is that all we're going to see from the fed? Are there other things that they were contemplating? What does that look like to try to, I guess maybe keep the economy moving along or give it the power, the fuel, the flexibility it needs to recover over time?

 

Frances Donald (00:16:41):

That's a fantastic question and it consumes us on a day to day basis, but, well, let me start at the beginning of here of how we got from hearing about a mysterious illness in China to seeing the fed buying corporate bonds. It didn't happen overnight even though it sometimes feels that way. It started in early January when the idea of a coronavirus hadn't even been named covert 19 yet we're circulating it and we believed. Most global economists recognized that China was dealing with a contained virus and it meant that global manufacturing activity just as it was beginning to recover from global trade Wars would probably be hit. That was the good side and at that time some people were calling for a manufacturing led recession, a mild one because of China's closure. Then in mid February, end of February, we started to realize that this virus was spreading and we might have to deal with what I call this services led precession, that we weren't just dealing with the good side of the picture of the supply side, but that demand and services would get hit as well, and that's where we weren't only March, and at that point, something sinister started to happen, which is that as people became very concerned and the market started to sell off, we started to see a pretty heavy dysfunction in a lot of key markets, including treasury markets, which are supposed to be the most functional, the most liquid, the most healthy of all of them.

 

Frances Donald (00:18:07):

Then they began to see some dysfunction in the credit markets as people said, you know what, if companies don't have access to revenue, they will go default. And the credit market began to see signs of stresses. Municipal bonds started to trade very, very bizarrely. I talked to municipal bond traders who said they'd never seen anything like that. Why? Because municipalities issue bonds and if nobody's working and there are no businesses, then how are they getting revenue? And then even more oddly as a federal reserve was cutting interest rates to zero mortgage rates were rising. How bizarre is that? And it was because banks were saying, we're actually nervous about lending. We think everybody's going to default. We don't want to lend or hiking rates. So the federal reserve is looking at a financial system that looks very similar to 2008 for a brief moment. There were spreads are blowing out aggressively and the concern Morse from being an economic recession to a financial crisis, and this is why federal reserve and global central bank stepped in.

 

Frances Donald (00:19:10):

They did not step in because they believed cutting interest rates to zero would have an impact on saving growth. Of course not. It doesn't matter what the cost of borrowing is. If people don't have jobs and nobody's going to the salon or the coffee shop or the bookshop, that was never the intention. The intention was develop a suite of products where we start being the buyers. So we will buy corporate bonds. Investment grade, we will buy municipal bonds, we will buy treasuries, we will buy mortgage backed securities, and we will buy so many of them that there will always be liquidity in this market and the market can kind of clear a little bit more easily. What's happened as a result of that is we have interest rates at zero and the federal reserve buying just about everything except equities. They are even now buying some of the high yield market.

 

Frances Donald (00:20:00):

They're buying some fallen angels, so bonds that were rated investment grade prior to coven 19 and then fell into disrepair and lost that rating. This is a massive structural shift. Japan had done this, Europe had done this for a long time, but the view was at the federal reserve, what's kind of stayed the more traditional policies, it is in some senses, very surprising to me that we have central banks buying corporate bonds. It means that that market has a backstop. I don't think it's a market that they're going to easily be able to exit. It probably produces some asymmetric risk because if we began to see sharp selloffs in investment grade credit, again, you'd probably see central banks stepping in again. And we're now moving towards something that looks a lot more like this, so called modern monetary theory in which central banks tell governments print or spend issue bonds and we'll buy them this.

 

Frances Donald (00:20:57):

If you had said to me in January that we'd have every major central bank in the world buying corporate bonds, municipal bonds, Bhardwaj backed securities, certainly at the level we are now, I would have said no way that it's too politically difficult. But again, many of these trends that were seated in 2018 2019 from modern monetary theory, even to universal basic income, we have even, you know, Republicans who are saying that's the right approach and, and that's what we're seeing governments doing is cutting checks and sending them out. This is really would have been unfathomable to a vast majority of my profession, but also I think the political atmosphere even three months ago.

 

Rick Unser (00:21:35):

Yeah. It's funny and I think there's so many things that I've heard that if, Hey, if you had a nickel for if in January you thought you're going to be thinking about this in March or April, you would have called me crazy. But I'm with you that I think that's one that I'm certainly no expert on fed policy, but that I would agree with you that people would have said no, no way. That that's, that's not gonna happen. Not here. Not, not based on how we've historically conducted business.

 

Frances Donald (00:22:05):

There's a lot that's happening now that I would have told you was not possible. I would have said negative oil, no way. Not in the American market. We even see negative interest rates on some of the very front end of the U S bond market to have, you know, deliberately shot the global economy. You know, it was never, I think intended to be shot as long as it was, but to deliberately shut the economy as it is and, and be handing out checks globally. This is not just the U S that has taken this approach. It's happening globally. It's skews our concepts that we learned about in econ one Oh one two Oh one through one four Oh one up to the grad school that I went to. But at the end of the day I think we still have a population that will search to keep its family safe to, you know, maximize its wealth and put its own self interests first. And in that type of environment, economic tools can still kind of give us some good concept of what will happen next. But getting used to headlines like this is the worst economic number we've ever had followed by this is the best economic number we've ever had. And seeing the market behave in ways that it never has before. That's probably something we should get used to for at least a couple of months.

 

Rick Unser (00:23:18):

Since you brought up the negatives there, negative interest rates, negative oil, I'll let you pick it off in whatever order makes sense, but how do you explain that to someone in terms of like what does that mean and what is the impact and how can that happen in our current economic reality?

 

Frances Donald (00:23:40):

Have you ever used one of those junk removal services where you've maybe got a couch in your basement that you really just want to get rid of and maybe you got a sore back. Maybe you don't. Maybe your friends are all busy at the super bowl and they can't come over and help you move it. So you call the junk removal service and you pay them to take your stuff. Are you familiar with the services? I've used those before. Yeah, absolutely. Got junk. Got junk. Okay, so I didn't want to give out a corporate advertisement so it was moving away from it. But yes, junk removal surfaces. This is very similar to what we're seeing in the energy market. I know it seems like I'm off the wall here, but essentially what we're seeing in in oil prices, oil is a physical market. Demand and supply have to clear physically and when they don't, we put that extra oil into storage.

 

Frances Donald (00:24:30):

But we have such a glut of supply, so much supply in a context of oil demand falling by 20 to 30% the storage facilities that are in existence globally are filled to the top. We have nowhere to put it. Now you might think, okay, well if you don't have anywhere to put the oil that's coming out of the spout, why don't you just close the spout? Except that it's very expensive to do that. There's all sorts of technical engineering reasons why actually slowing the pumping of oil costs a lot of money. So as we got closer to the may contract for oil prices, people were basically saying, anyone who's trading this and saying, I can't take it, I don't want it. Why don't I use the equivalent of a junk removal service to have people, I will pay you to take this oil off of my hands.

 

Frances Donald (00:25:17):

Essentially what that says to me is something very shocking. Now remember this is futures contracts. This is for may oil. So this is the expectation. And then the energy market that by may demand has not resumed and even today we're seeing that the June contract might go negative as well, in which case the energy market is telling you that even by the end of June, they don't believe that there'll be enough demand to soak up this excess supply occurring in the market. Now there's a variety of other technical reasons why oil prices went negative and actually a lot of people who sell oil, a lot of producers who sell oil do it on sort of a month average as opposed to a spot price. So it's not really likely that people actually sold barrels of oil at a negative price or literally paid for somebody to come take it off their hand.

 

Frances Donald (00:26:02):

That was probably more the contract, but this is a very powerful message, right? This is a market telling you demand and the economy will be so weak for the next two months that we actually believe the value of oil, energy, gasoline is the weakest it has been in modern economic history. We have to listen to markets that tell us this. We have to listen to the extreme numbers that we're seeing here and recognize that this economic shock that we're experiencing is not a multiple week issue but a minimum of of multiple months and it is so severe that it will throw a variety of our charts into mayhem. And now I know how it's not easy for me to say that because we're talking about people in jobs, in my friends and family who are going to suffer in this. You know, my parents who are relying on their retirement portfolios for income, but we also have to be clear eyed about what we're walking into and with the S and P rising and equities looking like a bounce back, I think we need to be very open and honest about the idea that we're not out of the woods yet.

 

Frances Donald (00:27:07):

There is an out of the woods, but it's not today and it's not next week.

 

Rick Unser (00:27:11):

Well, that prompts the question on my end of what does that scenario look like? When do market forecasters, when do economists, whatever, give that all clear sign or say, all right, Hey, the market is either found a bottom, the economy has found a bottom, whatever the case may be.

 

Frances Donald (00:27:33):

I have this funny dual role, which is I'm both a chief economist and the head of strategy and a lot of the time they're the same job. So I would say, you know, I think there's deflation and therefore interest rates will be very low, but every once in a while I can tell you the economy will do this and markets will do something, but it looks very, very different. And I think this is one of these cases in large blankets because markets are very forward looking. So they're usually telling us where things are going to be six months to 12 months from now. They are focused on things like earnings and valuations that are not always reflected by the underlying economic activity. Different asset classes have better relationships with the underlying economy. Now. When I look at the equity market right now, I see a classic bear market.

 

Frances Donald (00:28:17):

If you look at the last 10 bear markets that occurred in recessions, they look very similar to this, which is a minimum of a 15% meltdown, a bounce from very oversold levels, and then at least one new retesting of those lows before we can sustainably rise again, it looks like a w and my sense is that's exactly where we are right now. So the last two days we've seen a little bit more of a market sell off. I believe what we're experiencing now is that second leg down in the w now we will reach the point when we can have a sustainable rally on the other side, but it probably requires a few conditions. One is I do think we need to get through a difficult earning season and earning season. Then he's going to see dividends, Cod and buybacks pulled back and guidance pulled out from under us.

 

Frances Donald (00:29:01):

That makes valuations hard. I think we need to find a floor on oil in part because the energy sector is a critical component of risk and we need to make sure that we're not seeing as the Kansas federal reserve tells us 40% of us producers of oil go bankrupt with energy under $30 so we need to see some movement there. And then last, but probably most important, we need to see some sort of evidence that we health outcomes related to coven 19 will be much, much better. And that might be mass testing, it might be mass antibody testing, it could be evidence that a vaccine is eminent. Does the vaccine need to be distributed to everybody for the market to Raleigh? Absolutely not. The market just has to have conviction that we will get there. And that is something that has a reasonable timeline in front of us.

 

Frances Donald (00:29:46):

So those are the conditions that I'm looking forward to really call a sustainable bottom in the S and P. Now that said, if you have any type of strategic horizon, so I help manage portfolios that are looking out over the next week, month. We spend a lot of time thinking about the next five, 10 25 years. I do not think that anybody five years from now will be upset if they bought the S and P at 2,800 that is not something you're going to look back and say, wow, I really messed up on that call. We are still, in my view, in a structural bull market that will persist out at least five years. There will be gyrations along the way. There will be a call for active management as we see more selloffs that mimic what we witnessed in 2018 19 and 2020 but if you are a longterm investor, you should probably be comfortable at this point realizing that the next month, while we might have a lot of volatility is not going to look the same as the next five years.

 

Rick Unser (00:30:42):

And you made an interesting point there that I think has been a pretty hot bar, hotly debated concept here in the U S has been this idea of passive versus active management and let's just say for the bull market from the depth of the global financial crisis back in March of 2009 is when it started through this recent obviously coven related bear market. What we saw was just this massive migration obviously to passive or index investing based on this coven unrelated bear market and I think we're in a new quote unquote bull market. I think maybe you can clarify that for us. Are you suggesting or do you think that as we've kind of gone through this that maybe we see the floodgates start to move the other direction and there is more of a demand or there is more of a appetite for active management and that quote unquote skill set in the investment world?

 

Frances Donald (00:31:46):

I suspect so for a variety of reasons. One is that what we've witnessed in the past two to three years is that we will see a lot of more macro events that make it more difficult to just have a straight line higher. We are looking at de-globalization, we are looking at interest rates that are negative in several parts of the world. The search for Kerry, this is a more challenging environment over the next two to three years and what we've witnessed before, but we're also seeing problems for example in the ETF market, which is that in the past couple of months we've witnessed really large disconnects between the underlying value of something that's being traded as EPS. So you could maybe have a really good idea that you think the S and P is going to or credit is going to move 10% and then you buy the ETF and the ETFs is a halted.

 

Frances Donald (00:32:35):

We've seen energy ETFs halted just today or it move as much as the underlying, and that to me suggests that we have to have a little bit of a reckoning when it comes to how we express ideas through the ETF market. But generally I am expecting a lot more volatility. I am not expecting things to be a straight line higher and you know, people seeing their portfolios full like they have here. It says to me there might be more of an appetite. Now I also think we're going to see an appetite not just for active management but for additional forms of diversification. So I spend a lot of time talking about the value of infrastructure funds of real assets of thinking beyond the traditional 60 42 how do we diversify into different forms of credit? Emerging market credit is an entirely under owned asset class that I think has great potential over the longer term horizon and it's just not in portfolios of so many people as an appropriate diversifier. We need to be having conversations about not just how do you or do you use active versus passive, but how do we construct portfolios for this new future where search for yields will continue to be an incredibly important theme where we want to have in a spirit of much higher volatility, finding assets that have much lower beta to the S and P finding assets that are not so globally correlated with each other.

 

Rick Unser (00:33:59):

No, good point. And I think that's one thing that employers here that sponsor workplace retirement plans, I think that will be something that people really start to think about as the proverbial dust settles in the financial markets is okay, well I had 12 different investment options. I had a suite of target date funds and yeah, they had different names, they had different asset classes. But Hmm. You know, they, they kind of all acted a lot like each other during this time period. And are there things that we could add to our investment mix that might provide some different outcomes for people as maybe the world looks a little different going forward, etc. So I guess if you think about that, you mentioned a couple of things, but are there a couple suggestions for you know, broader plans with obviously pretty wide diversity of employee understanding or sophistication that you would say these are the maybe the first couple places I would suggest that you start having a conversation about an asset class or an investment category that might be outside that typical large cap or small cap or intermediate term, fixed income, et cetera.

 

Frances Donald (00:35:19):

Absolutely. I sit on the asset allocation portfolios managed by John Hancock and Manulife and one thing that was really shocking to me when I first started was I had a portfolio manager take me aside and he said, look, and at the time we were looking paying portfolios, but it's just as relevant globally as well. And he said, what do you think the difference was between the top performing and bottom performing the an equity manager? And I thought it would have been a a huge number, right? It was actually about 3% which is really important, right? We have to deliver those 3% for our clients. And then he said to me, what do you think was the difference between the top performing asset class and the bottom performing asset class last year, year and it was 26% so you can get the right manager and that's important, but you have to get the asset allocation decision right?

 

Frances Donald (00:36:09):

Because if not, you're really in trouble. And what's so challenging about the asset allocation decision is that there's no rhyme or reason. When we look back over multiple years, it's not the same asset classes that performed the best each year. We don't see any sort of real relevance to that. And it's not that if you were the best performing one year, you're the worst performing the next, there's no particular rhyme and reason to making that asset allocation decision based on that approach. You have to have these global teams that are looking beyond traditional asset classes that are incorporating those with lower beta, that are incorporating what we call opportunistic sleeves. So we care about things like making your asset allocation decision. Then having the ability to express high conviction ideas. I also think we need to talk about private assets, so private markets, real estate, all of these funds become more and more important and I do think there's a place in our portfolios of the future for hard assets, real assets as well. Things like gold I think are going to become important components of these portfolios. So you know, as we're thinking out over the next five to 10 years, and I think we also comfortable accepting that the world probably looks a little bit different now is the time to take a really good hard look about how your asset allocation decision matters in that type of environment because they're going to be here is when that asset allocation decision matters so much more than just your underlying manager.

 

Rick Unser (00:37:32):

One thing that I guess as I look out over the next three, five, 10 years that I'm hearing more people talk about, and as you say, things like hard assets or things of that nature. I think this ties together, but you tell me the concept of inflation and I think we heard a lot about that in the last financial crisis. Oh my gosh. You know, we're injecting billions of dollars into the economy and the only logical outcome here is that we're going to have massive inflation once things start to recover. I don't know that that ever really translated, but I feel like that drum is starting to beat again. You know, we've just injected now trillions of dollars into the economy here in the U S so that drum beat, I guess just to stick with the analogy is starting again where people are calling for inflation in the future. Do you think that becomes reality and does that then also maybe change how people should be looking at some of the investments in their workplace, retirement plans that they're making available

 

Frances Donald (00:38:36):

To their employees? In the immediate term, we need to talk more about deflation in part because oil prices have tanked and in part because we're experiencing, you know, this massive economic shock and it's just been destroyed demand for several months at a time. So you're actually probably going to see just in the next couple of months, deflation being the real threat. I am however, a little bit more focused on inflation now than I was in the post 2008 environment. And it's not because of central banks. The central banks create inflation is the red herring. The real inflationary component actually comes from the federal spending side of the picture. And what we're witnessing in the packages that have been developed in the United States and elsewhere is government spending that rivals postwar periods. So you know, we're the one world war two those are the deficits that we're going to see in this type of environment.

 

Frances Donald (00:39:36):

We can empirically show that monetary policy has become far less effective basically around 1995 and after that it stops being a real form of inflation generation. But fiscal policy and government spending, Peterson Institute says that a dollar of government spending can generate up to $4 of growth. So the multiplier effects from fiscal spending are actually the real powerful component here. And if we continue to see levels of government spending like this and we'll begin to see infrastructure programs, then I believe they will take hold within the economy and they do create some forms of inflationary pressure. Are we looking at scary levels of inflation? You know, 1970s style? No, because we still have these structural impacts on our global economy, not the least of which is demographics that we'll continue to put downside pressures on inflation. The digitalization of our economy is actually very disinflationary. The idea that, I don't know if this ever happens to that.