Tilting Portfolios to Leverage Macro Trends and Political Winds
The CFA Institute Equity Research and Valuation Conference is an annual event covering global investing strategies and valuation approaches and analysis. The Equity Research and Valuation 2018 Conference, hosted by CFA Institute and CFA Society New York, will be held 6–7 November in New York City.
Jack Ablin, CFA, has worked in the investment profession for over 30 years and during most of that time, the economic and social pendulums shifted only in one direction.
Ablin explained how the combination of demographic trends and monetary policy created tremendous tailwinds for economic growth leading up to the global financial crisis, discussed his thoughts on why growth is currently sluggish and provided his outlook for the US economy and financial markets during the administration of President Donald Trump.
Back in the 1980s, “monetary policy was a great way to stimulate the economy,” Ablin told the audience at the 2016 CFA Institute Equity Research and Valuation conference. US Federal Reserve chairs Paul Volcker and Alan Greenspan lowered interest rates and encouraged borrowing — and “borrowing begets spending,” according to Ablin. It started with corporations, then shifted to the consumer sector, which began taking advantage of the baby boomers’ “have-it-now sensibility” and their willingness to take on debt.
But after the financial crisis, the consumption music stopped. The Fed lowered rates again to stimulate the economy, but it didn’t work. Boomers, now empty nesters, began to downsize and save more for retirement. Millennial children, more prudent than their spendthrift parents, were more inclined to save, “and not stick their necks out,” said Ablin. As a result, savings rates have gone up even as interest rates have declined dramatically.
The Fed then took another tack, and with its quantitative easing (QE) programs brought down intermediate to long-term rates to try to lower the value of the dollar, boost exports, and spur growth. “That only works if you’re the only country doing it,” Ablin said. Japan and Europe followed suit and it was a race to the bottom. Global trade as a percentage of world GDP has been on a steady decline ever since.
Another unintended, growth-stifling consequence occurred when the European Central Bank (ECB) embarked on a massive QE program that included the purchase of investment grade bonds. Ablin believes this has influenced the positive performance of the stock market more than Fed policy. Large US companies began issuing corporate bonds in euros, immediately converting them to dollars, and then buying back their stock.
“With all the recent debt issued by corporations,” said Ablin, “they have not invested in R&D, automation, or capital expenditures” that improves productivity and creates growth.
Real household income and wealth relative to inflation is also lower today than in 1999. When President Ronald Reagan and UK prime minister Margaret Thatcher pushed globalization and free-market reforms in the 1980s, the growth and productivity created went straight to profits, not wages, Ablin noted. Wages rose dramatically in Mexico, China, and other emerging countries, but these gains came at a cost to the middle class in developed countries. New technologies also eroded the value of workers’ skills over time. “If you don’t retrain, your wages will trail inflation,” Ablin said. Small company formations, a major driver of job growth in the United States, have also been in secular decline.
More recently, Ablin sees the economic and social pendulums starting to swing in the opposite direction with more emphasis on job growth, infrastructure spending, and worldwide populist movements against “big government.”
“It took us 35 years to get where we are today and [the pendulum] may move back at the same rate,” Ablin said. “You should think of it as ‘changing winds’ or ‘tilting winds,’ not a sudden reversal.”
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