In the premier episode of Wilmington WealthWise with Tony Roth, chief investment officer of Wilmington Trust Investment Advisors, Tony welcomes Meghan Shue, head of investment strategy, as his special guest.

  • The first and second halves of the year are going to play out in two very different ways from an investment and economic perspective.
  • We expect the economy to continue to do well for the first half of the year, but believe the risk of recession will start to move up as the year draws to a close.
  • It’s too early for markets to price in election risk and policy risk following the election but, regardless of who prevails in November, there will be significant policy risks to economic activity, and markets will see that as we get closer to the election.

 

Please listen to important disclosures at the end of the recording.

 

Wilmington WealthWise with Tony Roth

Episode 1: Into the Unknown

Tony: Hello, welcome to WealthWise, the podcast dedicated to financial literacy, where we take complex ideas from the investment world and make them accessible to everyone. I’m your host, Tony Roth, Chief Investment Officer of Wilmington Trust Company.

Today we’re going to discuss the idea of productivity within the context of our 2020 outlook for the global economy and financial markets. I am so pleased to be joined today by my colleague Meghan Shue, who is the head of investment strategy at Wilmington Trust. Welcome, Meghan.

Meghan: Thank you. Thanks for having me.

Tony: It’s great to have you. So Meghan, we started this work, I should say you started this work last summer into the fall.

Meghan: That’s right.

Tony: And now that we see that it’s come together well let’s start with the name. Tell us what the name of the capital market forecast is for 2020.

Meghan: Yeah, our capital market forecast for 2020, is called “Market Tug of War, the interplay of productivity populism and portfolios.”

Tony: So we’re gonna focus on that idea of productivity today. And when we started this, we weren’t sure where it was gonna go. But now that we’re here in January, we’re talking about 2020. We sort of think the year is gonna play out in two acts.

First, we’re gonna have probably some opportunity to make some money in the markets. And then after that, as we get closer to the Democratic nomination process and the convention and then the ultimate election, there may be some weights on the market, some nervousness around what the election means, and what policy may be afterwards. So let’s talk about the positives to start. Let’s talk about this idea of productivity. We’re very focused on it, we’re very obsessed with it. Why are we

so obsessed with productivity? What is it? What does it mean?

Meghan: That’s a good question, so we are very focused on productivity, the financial media not so much, but we see productivity as one of the key underpinnings of long-term economic growth. So if you think about long-term economic growth, it’s essentially growth of your labor force or population growth, multiplied by the output, the growth, and the output per worker.

Tony: So this is like Economics 101, right?

Meghan: That’s right, and the first part of that the cause of the labor force is really based on demographics that are not looking so great in the developed world, in the U.S., Europe, and Japan. The second part of that is where we have a little bit more optimism and that’s around productivity, which relates to automation and globalization, and essentially doing more with less.

Tony: Meghan when I think of productivity I like to tell of a story that relates to my own life. I live in the small town, Bryn Mawr, Pennsylvania, and in Bryn Mawr, there’s a Starbucks on Lancaster Avenue, it’s a very busy street corner. It was when I first moved here I learned very quickly to always avoid that corner because there were accidents. So the Starbucks is a tiny little space and they have only six parking spots. And so everybody would come in with their big SUVs and they’d be fighting for parking spots go in and order their coffees their latte, frappe whappees, etc. And so I got to the market and I said, wow, I’m gonna avoid this area. Well, what happened was, ironically, over time, I realized that Starbucks had an app, and everyone else realized this at some point. So now we can order our coffees, five to seven minutes before we arrive. Somehow, we intuitively know now, when we’re five minutes away from Starbucks, in our busy lives, we order our coffees and we get there. And not only is the coffee ready, but in many cases they have a person that brings the coffee out to you and smiles at you, which is always nice. And then you whizz away. And so not only is it good for me because I get wired more easily now—which is the last thing that we all need. But nonetheless, it’s great for Starbucks because this technology is enabled the company to be 300% more efficient. In other words, the revenue of that shop, I actually asked the manager, the revenue has gone up by 300% in the 18 months since the app came out. So it’s really pretty remarkable what technology can do in the right context.

Meghan: Exactly, producing more with the same number of workers. That’s the definition of productivity.

Tony: So tell us what is the heart of the matter here? We think that the economy is doing well because of productivity?

Meghan: Yes, so we think productivity is one of the key drivers of our more optimistic economic outlook going forward. Productivity as measured is actually quite low. We’ll talk about that I think in a subsequent podcast. We expect that productivity is actually higher than what is reported and moving higher. And this is an important reason why we do have a more optimistic outlook for U.S. GDP growth of about a percent and a half this year. And I think where the rubber meets the road is that productivity is really about, as I said earlier, doing more with less; so, higher economic output without generating the inflation and this is a recipe for an elongated economic cycle.

Tony: I know that’s one of the key ideas is the inflation because we have low inflation, we have low interest rates. I don’t think we’ve ever had an economic cycle before where we were so late in an economic cycle and we had a Fed, which was actually significantly accommodative below what they call their neutral rate, so they’re actually continuing to put the foot on the accelerator and they’re not worried about inflation.

Meghan: Globally, central banks are very supportive right now, which is one of the key reasons why we are overweight equities in our portfolios.

Tony: Okay, so we’ve got this very rosy story here and productivity is a big contributor to it. But I know that it’s a double-edged sword. So there’s a sort of an ugly underbelly to productivity. Tell us about that.

Meghan: Yeah, so productivity is really stemming from two things. Globalization and supply chains that just becoming much more efficient and diversified, as well as automation. So while that is improving productivity, making companies more efficient, improving the bottom line in corporate profits for companies, it’s also having the effect of displacing workers, increasing income inequality.

And all of these things are leading to populist sentiment, essentially disenchantment with the establishment, if you will. And policies that we’re seeing in the lead up to the 2020 election that have some populist tinges to them. Whether it’s on the left, and you’re talking about potentially tax increases, or on the right, where you’re talking about tariffs and some trade wars with our trade partners, China and others.

Tony: Yeah, and I think in the report, we actually call that the irony of productivity, because on the one hand productivity is creating this great talent to the economy, and it’s creating more efficiency and that’s all wonderful. But on the other hand, it’s been very disruptive to workers. And the share in GDP of income on the part of workers is as low as it’s been in decades. And so it’s created wealth inequality and it’s created income inequality, and you put all that together and you have some unhappy people on both sides of the political spectrum. So okay, so when you put it all together, what’s the outcome?

Meghan: Yeah, that’s where the tug of war comes into play. And we do see productivity winning out, if you will, in the first half of the year, where economic growth is expected to, perhaps in the U.S. decelerate a little bit from last year, but still remain well in expansion territory. But as we get closer to the election, we think some of the more populist-related risks, some of the policies that are out there being proposed are probably gonna create some jitters, maybe some higher volatility in the market. And at that point, we could at least hit the pause button; if not, see some more choppiness in financial
markets in the second half of the year.

Tony: Right, in terms of the election itself, one of the things that we’re concerned about, of course, is after you have the election, you’re gonna have an administration that has a period of time before they have to worry about the next election and they’ll really be able to pursue the policies that resonate with their base. And so if that’s on the one hand a continuation of the current administration we could see a second round of tariffs, which could really be a headwind to not only the U.S. economy, but the global economy.

The Trump administration is already talking about Europe being in the crosshairs, the UK; apparently the UK even today announced that Huawei is going to participate in their 5G, and the Trump administration’s not happy about that. So there’s a lot of saber rattling around populism there. And then on the other side of the continuum, if we have a Democratic administration, we could have higher taxes and everybody knows higher taxes typically slows down the economy.

Meghan: Yeah, and as you’re pointing out, there’s a lot of risks regardless of who ends up In the White House in 2020. And so part of the way we think about it is looking at those individual policies, where are the risks in our portfolio and essentially shoring up some of those holes to try to mitigate what could be the potential outcome while it’s still far too early to tell what that outcome might be.

Tony: So tell us real quickly how we’re positioned today.

Meghan: Yes, so that first half optimism is resulting in an overweight in equities in our portfolios. And we are actually neutral to U.S. large cap, which has had a phenomenal run. But valuations are looking a little toppy, and instead we are overweight U.S. small cap, where we see some potential catch-up to U.S. large-cap equities, partially because of what we expect in terms of a reacceleration of global economic activity and a receding of trade tensions. And international developed is another area where we are overweight right now—again, because we expect those more export-oriented economies to benefit from receiving trade tensions and a pickup in global economic activity. U.S. small cap and international developed also should be, I should note, do have much more attractive valuations than some other areas of the market.

Tony: Terrific, so let me just summarize real quickly, what I think are the three key takeaways for our audience today.

One is that due to productivity, we’re not gonna have a recession this year, we think that the economy continues to do well, continues to expand. Number two, we think the first half of the year in the markets is likely to be better than second half of the year. And that’s because we think that it’s too early for the markets to price in election risk and policy risk following the election. And regardless of whether we have a Democratic or Republican outcome in the fall, there are gonna be some significant policy risks to economic activity, and the market will start to see that as we get closer to the election. And then last, we think that as we move into next year, we think the probability of a recession starts to move up. And we start to need to think about that definitely before the end of this year as well.

So the last thing I wanna talk about real quickly before we end is, we always worry about what we think of as the black swan or the exogenous event. And we’ve had a couple of this year already we’ve had Iran and we’ve had the coronavirus. So Meghan when you think specifically about the coronavirus because we think Iran is pretty much abated for the time being, how do you think that’s gonna play out and what impact might that have on the story that we’ve just told?

Meghan: Yeah, it’s a great question. And a lot of the questions that we have about the coronavirus still remain to be answered. We’re still learning every day, we’re learning more about the number of cases, the mortality rate, how it’s spreading. It does look at this time like it is perhaps lower mortality rate, but spreading perhaps more quickly because of a longer period where you’re not showing symptoms, but perhaps still contagious.

On the whole, we see these events historically as we look back we have very few to look at, but historically they have had an impact more on regional economic activity. So we could see some slowing in the first quarter or second quarter of this year in China and maybe the surrounding Asian economies, probably not as much in other developed parts of the world. But it’s a risk that we’re watching and we are not altering portfolios at this time due to the coronavirus risk. But is something that again, we have to keep our fingers on the pulse of what is happening there because it can have an economic impact particularly in China or the region.

Tony: Before we say good bye, I want to invite our audience to join for our 2nd podcast which will feature our chief economist Luke Tilley. And Luke and I will discuss productivity in more depth. Specifically, we are going to talk about what we call the paradox of productivity. The paradox of productivity is essentially the idea that we see our lives changed every day, our reality is different all around us as a result of technology, but we don’t see it in the numbers. Economists aren’t seeing productivity show up in the numbers. So we are going to talk to Luke about why that is, and he’s going to hopefully explain it to us.

So thank you again for joining today. For further information about our outlook for the year 2020, we invite everyone also go to www.wilmingtontrust.com/cmf.

Thank you for joining.

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