When Barron’s gathers some of Wall Street’s best minds—as we do every January for our annual Roundtable—we expect some consensus, some disagreement, and one or two off-the-wall notions that sometimes turn out to be surprisingly prescient. This year did not disappoint.
Investors entered 2020 with the financial markets heading higher and a lot of optimism about the economy. Then the latest flare-up in the long conflict with Iran reminded everyone of the many geopolitical risks lurking under the seemingly placid surface of the market.
But the 10 veteran investors and economists who convened in New York on Jan. 6 at the Barron’s offices agree that there’s almost no chance of a recession this year, and their view of stocks is decidedly, albeit cautiously, optimistic.
They all spoke of high valuations and noted a lack of catalysts to drive stocks higher. That led to some bemoaning that it’s becoming increasingly hard to find good value in today’s market—so perhaps it’s no surprise that there were a few overlapping stock picks and a handful of familiar ideas. Where was the dissent? It centered on what the Federal Reserve’s next move would be. The biggest surprises were in the discussion around this year’s presidential election.
Our panelists raise different concerns about China, agree on the need for increased immigration, and see an almost certain win by Donald Trump.
Two new people joined the fray this year. Sonal Desai is an economist and chief investment officer of the $154 billion fixed-income group at Franklin Templeton; James Anderson is a veteran international money manager with Scotland’s Baillie Gifford, which, among other things, subadvises the Vanguard International Growth fund.
This week, we present the panelists’ views on the global economy and financial markets. Over the next two weeks, each will make the case for their best picks for 2020.
Barron’s: Let’s keep it simple. What do you expect for the economy and the market in 2020?
Abby Joseph Cohen: In the U.S. and a handful of other nations, including Japan and in Europe, 90% of stock market gains in 2019 were due to multiple expansion [investors’ willingness to pay more for the same set of corporate financials]. But 2020 will likely be a year of much more modest gains, and they will be closely linked to corporate profit increases—which, in most of these countries, will be in the mid-single digits. In early 2019, equity markets were undervalued, following the sharp price declines in late 2018. The S&P 500 index price/earnings ratio rose from 14 times to 19 times during 2019. At current prices, the S&P is within a whisker of fair value, and there’s not much margin for error. Looking for potential sources of error, there are the usual economic factors, which in 2020 may include some inflation and a steepening of the yield curve. Baked into the cake is the assumption that Fed policy will be unchanged and that interest rates won’t rise.
Valuations of bonds and other fixed-income instruments seem extreme in many countries; there are still negative interest rates in several developed economies. They seem overpriced. Other worries include geopolitics, with the U.S. election at the top of the list, accompanied by impeachment.
What isn’t baked in the valuation cake are possible foreign-policy developments. Clearly, there’s a lot of discussion about the U.S., with respect to Iran and North Korea, and whether there is a consistent policy. These are sources of potential volatility for U.S. equities.
Where else is there potential for error?
Cohen: The phase-one tariff agreement [with China] that we expect will be signed on Jan. 15 will be only a partial deal and will not get us back to tariff levels prior to recent months. But the real, consequential economic issues with China haven’t been tariffs: the issues are protection of intellectual property, forced joint ventures, limited access to Chinese markets, and so on. The phase-one deal is incomplete.
The Trump Administration has made economic policy blunders with regard to the international arena. Among these were the withdrawal from the Trans-Pacific Partnership, which occurred during the first days of this administration. The TPP, a broad trade alliance, was designed to serve as a buffer for nations around the Pacific Rim against Chinese trade practices. We all know the TPP wasn’t perfect, and was criticized by politicians in both U.S. parties. However, it was one source of protection for the U.S. and our trade partners in East Asia, South Asia, and the Americas. The U.S. has also failed to participate in the new iteration of the Asian Development Bank, ceding more ground to China.
I view the withdrawal from the Paris climate agreement as a blunder, as well. For the first time, all the nations on the planet, including China, signed to a climate accord. By not participating, the U.S. has given China more range to do what it wishes. U.S.-based multinationals are moving ahead with Paris compliance, in any case. But the elimination of some environmental regulations in the U.S. are ultimately damaging to the economy. You might get a short-term burst of activity in some selected industries, but the overall consequences are negative. The auto industry now has multiple sets of regulations, adding to its expenses. Companies that have been leaders in renewable energy, recyclables, and new materials could have been enormous areas of growth within the U.S. and in worldwide markets. Instead, we may fall back.
China is the north star for what’s going on in the change in financial payments globally.
Todd, you look for companies that do the right thing with regard to environmental policy and have excellent corporate governance. Do you consider the market too pricey?
Todd Ahlsten: Yes, from the first top-down view, the market looks fully priced; it is a year to be more defensive. We expect more volatility, and tepid economic growth. The Fed being on hold is a bet I would be careful to take.
Sonal, you’ve said that the economy is stronger than most people think.
Sonal Desai: I find myself out of sync with most people on the issue of trade. This administration has changed direction on trade policy 140 characters at a time. That was disruptive. But the idea that the U.S. can go back to a pre-Trump world in terms of trade is highly unlikely, regardless of the outcome of the November election. Some level of trade tensions are here to stay. Trade has been this massive negative, from the perspective of sentiment and markets. The real U.S. economy isn’t as influenced by trade as its markets are. I would be far more focused on the elections as a source of volatility and potential policy action, postelection.
Last year, the Fed blinked when the market sold off. [The Fed cut interest rates, starting in July, after raising them four times in 2018.] When the Fed did its famous pivot, the economy was growing pretty much as it is growing right now. The Fed boosted asset prices; its mandate is full employment and controlling inflation. I am not coming into this year expecting something dramatically negative on the underlying economy, which is pretty darn strong and we need to keep that in perspective.
If the Fed’s raising rates causes the stock market to fall, and if that causes the Fed to cut rates, that’s an endless feedback cycle. How do we break out of that? Or do we have low rates forever?
Desai: Excellent point. When you have a year with flat earnings and a stock market that goes up 28%, that cannot be a comfortable place for a central bank to be. The Fed has to have recognized that, and I don’t think it is going to jump in there cutting rates. This is a robust economy, so I don’t think it is an endless loop.
Do you expect inflation to rise?
Desai: Pre–global financial crisis, we all talked about the great moderation—great growth, low inflation, low volatility. It was all fantastic and going to go on forever, until it didn’t. Then we were going to have a series of Minsky moments [a sudden, major collapse of an asset class, marking the end of a growth phase], until we didn’t. Now, everybody is talking about “secular stagnation,” and assuming that means you can build up debt, have low interest rates, and inflation is gone forever. These are heroic assumptions. You have to look out longer than five or 10 years, and you can’t assume massive expansion of monetary balances by central banks is going to have no impact on inflation.
Rupal J. Bhansali: Inflation is what breaks this feedback loop. We are so used to hearing that inflation is below the 2% target. It isn’t. It’s over 2% in the U.S., and wage inflation is running well north of that. Part of the reason the markets went up is because they always go up when you have real [inflation adjusted] negative interest rates, and that is what we are experiencing. That is the real canary in the coal mine. Higher-than-expected inflation will put an end to this party like nothing else would.
The reasons for being both bullish and bearish on the economy are that the consumer is very strong, but the manufacturing sector is not. So, it is a two-speed economy. The consumer is very strong, partly because employment is at record lows and partly because wage inflation is very strong, much higher than the consumer price index. It is running at 3.2%, compared with the headline CPI of 2%, and that’s a very healthy increase. Consumer credit is running at a 4% growth rate, while lending to small and medium-size enterprises is flat. If you look at manufacturing globally, it is in a tailspin. [The ISM Manufacturing index is at a 10-year low.] The auto industry is at the vortex, but aerospace is following suit because production cuts are about to happen in 2020. Surveys show consumer confidence is strong, but CEO confidence is at its lowest since 2009.
Will the industrial side get bad enough to have an impact on consumers?
Bhansali: It inevitably does, because the two are linked. Though manufacturing accounts for only 11% to 13% of gross domestic product, when it contracted in the first and second quarters of 2019, the Fed lowered rates despite inflation hovering at or above its stated target of 2%. If inflation rises well above 2%, it may force the Fed to raise rates. This may eventually end up hurting the consumer and the economy. In short, the economy may do fine, but the stock market won’t. Given how richly valued the markets are, if you have any hiccups in the credit markets, it will have a disproportionate effect on the equity markets because of the amount of corporate leverage and underfunded pension liabilities. It would not surprise me if we go into bear market territory because of those two starting points.
William Priest: Three things drive the market—earnings, dividends, and price/earnings multiples. Dividend yields are a little less than 2%; that’s going to continue. Earnings gains will be fairly modest—3% to 5% are the consensus. So we are talking 5% to 7% growth, until you come to the P/E problem.
What is the P/E problem?
Priest: We will see very little upside from multiple expansion, but the downside could be substantial. I agree with Rupal; we are going to hear more about inflation this year, and it is unclear what the central banks are going to do about it. Inflation is never a problem until it gets into wages, but once it is in wages, it becomes a big problem. We know from history that inflation can be hard to control.
However, technology is incredibly deflationary. If a business can hold its revenues constant and substitute technology for labor, its margins go up. If it can substitute technology for fixed assets, its sales per dollar of assets rise. Everyone is trying to build a “capital light” model. But one of the things the market has overlooked is that payout ratios will continue to rise, as this model is deployed. Dividend growth will be surprisingly good.
Policy uncertainty is also a huge issue. We have entered a new Cold War, and that is negative for global growth. We’ve had more than 20 years of the benefits of globalization, which is being unwound. Comparative advantage is now going in reverse, which will limit economic growth. As a result, there is more downside than upside to the market. If the president is re-elected, Trump unchained will be a lot more unpredictable than the Trump we have today, and the uncertainty surrounding that will exacerbate volatility.
Cohen: [The risks of deglobalization] are not just about the flow of goods. We also need to talk about the flow of people. We know from economic history that nations with growth in their labor force have the fastest economic growth. One of the reasons the U.S. has done so well, relative to other developed economies, is because the growth rates in our population and labor force have been higher, and much of that growth over the past 10 years has come from immigrants. Our domestic growth rate is lower because the birth rate is lower for the current household-formation generations. Also, baby boomers are aging, and the death rate is rising. We’ve made up the difference with immigration.
The fastest growth in job creation is at either end of the skills spectrum—high-level health care, information technology, and so on, and low-end health care and hospitality. Those broad areas are largely filled by immigrants. Over the last handful of years, the immigration rate is down. Visas for people who have special skills or visas for students are down 20% to 40% since 2015.
James Anderson: It is amazing to have seen America throw away its biggest comparative advantage in the way it has, particularly with regard to highly skilled, inventive people. The percentage of your great companies founded by immigrant families is staggering. It is not talked about enough.
Cohen: More than a third  of the  Nobel Prizes awarded to the U.S. in the past 10 years in the natural-sciences categories have gone to foreign-born Americans.
Henry, what’s your outlook for 2020?
Henry Ellenbogen: I look at 2019 as a year the Fed really pivoted, and focused on driving inflation to be consistently above 2%, more than its other mandates. The real question: What is going on in the world structurally that is narrowing the Fed’s focus?
It’s interesting to look at what has happened from a technological standpoint among the large platform companies over the past 10 years, allowing for lower unemployment without the wage pressure to link it to inflation. These forces have changed not only our central bank’s policies, but also the policies of central banks in Europe and Japan. And if you look at the demographics Abby alluded to, Japan’s labor force peaked in the ’90s, and Europe’s peaked 10 years ago. And, unless we get immigration started, ours peaked last year. The number of working-age people in the U.S. declined in 2019.
Meryl Witmer: What are the legal immigration numbers?
Ellenbogen: I don’t know the absolute numbers, but immigration has gone down by close to 50%. Our population growth is 90% driven by immigration.
Cohen: We’ve looked at the economic impact of immigrants, and first-generation immigrants are the people who tend to fall at the two ends of the skill spectrum I mentioned. Some do quite well economically, others not so well, and this includes those who come in an unauthorized manner. When you look at the second generation, individuals with at least one parent who was an immigrant do dramatically better than their parents. They become significant taxpayers.
Desai: I’m a little puzzled why everyone assumes that current immigration policy is permanent. It can change as quickly as November, or four years from then. It is premature to assume that the medium term is going to look the way the short term does. The same is true for productivity [concerns]. It is the height of arrogance to believe that since we’ve seen low productivity growth in the past five years, we are never going to see strong productivity again. Twelve years ago, there wasn’t an iPhone, and presumably none of us could have predicted back then that we would have computers in our pockets.
The percentage of your great companies founded by immigrant families is staggering. It is not talked about enough.
Let’s talk about technology and its role in the economy and dominance in the equity markets.
Ellenbogen: It’s important to look at how technology disruption has really changed the world. In 2010,
[ticker: AMZN] had only $24 billion of gross merchandise value, or GMV, globally, and they sold a billion units. At the end of 2019, those numbers were up 10 times: They have $240 billion in GMV and will sell close to 11 billion global units. Amazon is deflationary for consumer prices; e-commerce has about a five times spillover into prices in the offline world.
Two of the panelists’ stock picks last year included
[DIS], and [CEO] Bob Iger was chosen to be Time’s business person of the year. What did he do with [new online streaming service] Disney+? He priced it at $6.99 a month. Now, U.S. consumers can get
[NFLX] and Disney for under $20 a month, instead of spending $80 to $90 on a cable bundle.
These platforms are cutting out the middleman. The surplus of disruption is going to the tech companies—seven of the top 10 companies around the globe by market cap are in tech—or going back to the consumer. This is why we have 3.5% unemployment, and how we have wage growth, but not the spillover into inflation. We estimate that 30% of S&P companies are under threat of disruption; this disruption will continue, and will benefit the consumer. That will allow the Fed and other central banks to stay accommodative, which creates a reasonable environment for investors. But you’ll have to be very selective. Find companies like Disney that can transition to the way the world works now, or find new platforms.
Bhansali: I’m going to challenge that. Service-cost inflation in this country is running at close to 4%. It is goods inflation that is at 0%. We are exaggerating the effect of technology. If you look at what a family spends on services versus goods, service inflation is what you should really be measuring.
[UBER] and Netflix are revolutionary, but we have had these sorts of revolutions all along—they just weren’t tweeted about, and they weren’t as consumer-oriented. But if they are really that disruptive and deflationary, why are we seeing this level of services inflation?
Ellenbogen: If you are a high-cost retailer with a lot of middlemen and distribution and high-cost real estate, you basically are going bankrupt or you are massively losing share. Online commerce accounted for more than half of the growth of all commerce in the U.S. That’s why there is no goods inflation.
[WMT] responded to Amazon a couple of years ago by acquiring [online retailer] Jet.com, and there has not been inflation in that basket of goods. Media is not a huge part of GDP, but it is representative. And now you can get content for $20 a month, instead of $80.
Bhansali: Your cost of rent has gone up, your cost of health-care services has gone up. These are the bigger expenditures.
There seems to be a greater push from investors for these disruptive companies to become profitable. Will that change technology as a deflationary force?
Ellenbogen: The real question is government regulation. If the Europeans lead, that could lower the deflationary force of technology.
Because of Europe’s efforts to protect people’s privacy?
Ellenbogen: Yes. It is the large consumer platform companies—
[FB], Amazon, Netflix—that are providing transparency of information, which is putting pressure on the price of goods and forcing companies to cut out middlemen to get goods more efficiently to the consumer. And the consumer is getting that surplus.
Ahlsten: Another aspect of inflation: At some point, climate change will be a big deal. We’ve been underpricing the cost of energy for a long, long time, and we all know that energy is the lifeblood [of the economy]. Climate change, at some point, sparks inflation. We have a legacy economy, but at the same time we have to invest in the new economy—the cost of stranded assets and new investments will cause a lot of volatility and inflation.
Anderson: I’m absolutely with you on that fundamental point about climate. But, ultimately, alternative energy is likely to be extremely deflationary.
Mario Gabelli: You have to take the power from the wind and solar, and couple it with battery storage. We all agree that the cost per megawatt is declining sharply. But you have to distribute it. Ideally, the distribution would go underground, but the cost of a mile of underground transmission versus overhead wires is two or three times greater.
Cohen: There are huge structural changes in the economy, be it in technology, climate, or pricing of various goods and services. It is important to note that the official data which are reported at these critical economic inflection points are often wrong, because the underlying sampling techniques are woefully out of date. For example, much data from the Commerce Department’s Bureau of Economic Analysis, or BEA, relies on a previous census of manufacturers and other companies that may have been completed five or seven years earlier. The companies that were important then have their activities overweighted in the current statistics. And which are underweighted? The official data may be underweighting all the new, exciting stuff in the economy. The mismeasurements can include production, pricing, and also the labor markets because the growing categories are under-represented in the surveys. Sonal raised the notion of productivity; the same is true there. It looked terrible when reported in the 1990s and early 2000s. What we found out several years later, when the Commerce Department finally revised the data, is that GDP growth was almost a percentage point higher than originally estimated, which meant that productivity was a percentage point higher. I doubt that today’s mismeasurement is as large as that, but there is some mismeasurement.
We focus so much on Silicon Valley and all the innovation we see as consumers, but the health-care industry has undergone enormous innovation.
Are we mismeasuring stock data, too?
Cohen: Some of our stock market data are skewed, as well. We focus on a very small number of companies that are performing extremely well. There is a huge difference between the mean and the median performance. This can be seen not only in share prices, but also in the performance of the underlying companies.
Ellenbogen: There is something broader going on in the market. It is also shrinking in terms of names. However, the private market is getting larger, though that will have a little bit of a pause. The narrowing in the market is not just driven by the dominance of the tech companies, but also by investors’ belief that a smaller part of the market has a positive terminal value because of the secular changes we’ve talked about.
Does a top-heavy market make it harder to pick stocks? Apple is 5% of the S&P.
Scott Black: It’s 4.55%, actually, but who’s counting? To your point, the top five stocks—
[MSFT], Alphabet, Amazon, and Facebook, are 16.7% of the total weighting. The performance of Microsoft and Apple alone accounted for half of the increase last year in the information-technology sector. It was up 48%, and the two of them accounted for 24% of that. Some of this is heavily skewed because of exchange-traded funds—in 1980, there were 11,500 publicly traded U.S. companies; there are 3,600 today, and almost all of them are in various indexes. It makes it more difficult to find inefficiencies than it did in 1980 or 1990. Not impossible, but much more difficult.
Anderson: There are always a small number of companies that dominate the stock market. We looked at the research of Hendrik Bessembinder at Arizona State University. Since 1990, the entire added value of equity over U.S. Treasury bills globally has come from just 1.3% of the companies.
Cohen: One reason the U.S. has outperformed is that is has a heavier tech weighting than any other market. Other markets, [such as emerging ones] have a heavier energy/commodity component. That was the worst-performing sector last year.
OK, it’s time put you all on the spot. What’s your prediction for U.S. GDP and the market at the end of 2020? Mario, you first.
Gabelli: We have a $90 trillion global economy. The U.S. is around 24%, reflecting the strength of U.S. economy and the dollar. Europe is about 22%; Japan, 6%. Europe is going to get a little stronger in 2020; Japan will be up a little bit. I’ll give developed countries 2% real growth, with the U.S. in that area, assuming we don’t have oil going to $100 a barrel. China will grow over 6% real. Overall, I see 3.2% real growth for global GDP.
The markets will be up in the first half of 2020 and turn down in the last 90 days of 2020, because there will be a lot more uncertainty for 2021. A major agreement between the Democrats and Republicans on an infrastructure bill could change that outcome. That is a missing ingredient in the U.S. economic outlook for 2021.
Ahlsten: It’s going to be quite a volatile year. Multiple expansion will be tough to come by, so with earnings growth in the mid-single digits, a starting framework is a mid-single digit year [for stock returns].
Desai: For 2020, I’m looking at 2.5% to 2.75% [real gross domestic product growth], and agree that the VIX [the Cboe Volatility Index] will go up for a variety of reasons, political and otherwise. It takes very little to topple from a steep valuation; I would have to agree, based on where your market appreciation comes from, that mid-single digit returns on stocks sound right.
Cohen: With GDP at that level, what sort of interest rates do you expect?
Desai: The Fed is going to keep short-term rates anchored where they are, and I continue to believe that this is a mistake, as monetary policy is too accommodative for the state of the economy. I expect the long end [of the U.S. Treasury market] to sell off a bit, on the back of inflation, despite the deflationary or disinflationary consequences of technology. The strength of labor markets argues for that. Finally, while goods price inflation has remained muted, that certainly is not the case for asset price inflation.
The R-word came up quite a bit in our discussion last year, but no one has mentioned recession today.
Priest: A recession is defined as two consecutive quarters of negative real GDP. The sum of the growth in the workforce and growth in productivity has to be a minus sign. It’s almost impossible to get that in the U.S. right now. I think U.S. real GDP growth will be around 1.5%, with overall global real GDP growth at 3% or a bit less.
Witmer: The consumer is in good shape; consumers will continue to spend, and the Fed looks like it will be very cooperative. We usually say slow growth is nirvana for the market, but with valuations this high, I would not expect a robust year for the market. Everything I look at is trading where it should trade in 1½ or 2 years from now, which means valuations are 15% to 20% too high. We could have a really sideways-to-down market; if something happens to cause fear, it could really topple. Then, maybe we’d get some good valuations again. It’s good to have some cash around. Cash levels for retail investors are still kind of high, but down from last year.
Ellenbogen: I see modest real GDP growth in the 1.5% to 2% range. I agree with Meryl that the consumer is strong and the markets are relatively full. I am the opposite of Mario—I think the markets are going to be weak until we have some certainty, not only on the presidential election, but also on whether the Democrats take the Senate. The three swing factors for the year are the Fed, China, and the election. The Fed will remain accommodative. I don’t think China has forgotten what’s happened over the last couple of years. And there will be clarity around the election and whether there is a change in fiscal policy and taxes.
Scott, what’s your view?
Black: I see three overriding themes. First is the resolution of trade problems with China. The second is the accommodative behavior of the Fed. The final one is the outcome of the 2020 presidential election. Let’s start with the China piece. Notwithstanding all of the tariffs, our current account trade deficit went down only $8.3 billion, to $724.2 billion. It did drop about $50 billion with China, but it went way back up with Mexico. Vietnam was the big beneficiary. Most economists knock 100 basis points off real GDP because of disruptions, especially in supply chains from technology, manufacturing, or just consumer products that are made in China.
The second theme is the Federal Reserve. They’ve rewound the balance sheet for $448 billion. People haven’t paid attention to it, but they’ve been producing massive amounts of liquidity with QE4.
[Fed Chairman] Jay Powell politicized the Fed this year. Inflation is under 2%, and unemployment is at record lows, unseen since the Johnson Administration. I know he wanted to stave off recession, but Powell went overboard to get [the federal-funds rate] down to 1.5% to 1.75%. That reflated assets and the stock market rallied big time from August to Dec. 31.
But he’s out of bullets. God forbid we have a major recession—it’s not like the days when you had a 5% or 5.5% rate that could be dropped to push up the economy. I think Powell will be accommodative until the 2020 presidential election outcome is clear.
Unless we get a left-wing Democrat as president, the stock market could rally 5% or 6%. You’ve got a 1.9% yield, so that’s about a 7% total return.
What if Elizabeth Warren or Bernie Sanders wins?
Witmer: What do you think? Would the market drop 25%? 30%?
Black: I don’t know. I’m not [hedge fund manager] Leon Cooperman; he predicted the markets wouldn’t open the next day if Warren won.
Getting back to my outlook, the S&P year-end [earnings] estimate for 2019 is $158.13, which represents a 4.3% gain; these are bottoms-up operating earnings. The 2020 estimate from S&P is ridiculous—$175.52, which would be up 11%. That isn’t going to happen in an economy of 2% growth, and 2% inflation, for 4% nominal growth. I am trying to be more realistic. I have earnings up 5%, which should take it to $166. A swing in energy stocks at this price would add another $4 in earnings.
If you take [the recent] close of 3234.85 on $166, you’ve got a 19.5 P/E. It’s expensive. And small- and mid-cap stocks are more expensive. The Russell 2000 and 2500 are both at 21 times this year’s earnings. It is increasingly difficult to find good values out there.
But unless we get a left-wing Democrat as president, the stock market could rally 5% or 6%. You’ve got a 1.9% yield, so that’s about a 7% total return. You can be slightly optimistic that corporate profits will grow. People will continue to invest. Interest rates are so low, they have to find a haven for their money, and that is the U.S. equity market. Growth rates in the euro zone are negligible.
Desai: For the euro zone, I would say 1.1%, which is essentially growth at potential. In the euro zone, the anomaly was the high growth we saw a few years ago. Absent structural reform, it’s difficult to see a sustainably higher growth rate there.
Black: A resolution of the China issue would inject a lot of confidence. If you read some of these chief financial officer consensus reports, they just haven’t felt confident in investing in capital equipment without seeing a resolution.
Cohen: Some of the weakness in business investment is attributable to the reversal in energy capital expenditures over the past three years. However, much of the overall decline is related to managements determining that potential returns on new investments were not impressive.
Bhansali: Isn’t it ironic that all chief financial officers feel uncertain about the economy, but they feel very certain about buying back their stock? We had record levels of share buybacks last year, around $960 billion.
Cohen: Buybacks are decelerating.
Bhansali: Decelerating from a growth-rate standpoint, perhaps, but absolutely still growing. This was the first year in a long time, if not ever, that total buybacks plus dividends exceeded the free cash flow generated by the corporate sector. The difference was made up by borrowing. So it seems that CFOs certainly feel very confident in investing in the stock market.
Cohen: So why are many companies borrowing, if they have a surfeit of corporate cash? It is linked to the opportunity of borrowing at decades-low interest rates.
Let’s get back to your forecasts. James, what do you see for 2020?
Anderson: One of the main reasons, if not the main reason, that active managers have struggled is because they ask these types of questions, with unknowable answers, where they have a very low probability of being right, and a low connection to the stock markets. It would be much better for us all to concentrate on the underlying structural changes in the economy.
Are you feeling good or bad about the markets?
Anderson: I’m feeling great. The type of disruptive activity that Henry has eloquently talked about will accelerate and affect the next 10 years. Therefore, we will have great opportunities in stocks.
What optimism. Bill, your thoughts?
Priest: The problem for me is P/E expectations and the level of policy uncertainty. Bloomberg has a policy uncertainty index; it’s never been higher. That speaks to lots of possible outcomes that are really not great. One is this Cold War II; we have entered a cold war that is going to last a generation. The players are the U.S. and China; the platform, trade and technology. The stakes are our values versus their values: market capitalism versus state capitalism, our Bill of Rights and an independent judiciary, or a model with neither.
I spend my time looking at what could go right and what could go wrong, and there are a lot more things on my ‘what could go wrong’ list.”
Should we rethink what global scale looks like in a world bifurcated by the U.S and China?
Ellenbogen: Well, there already are two internets. China has a separate internet and different internet titans:
[700.Hong Kong] and
Alibaba Group Holding
[BABA] are two of the top 10 market-cap companies in the world. This [dual internet] has real ramifications, such as the U.S. discussion around whether we should pull TikTok because of national-security implications. Meanwhile, when you look at the dominant U.S. global and internet companies, their valuations are basically ex-China, because they do not make money in China.
Gabelli: If I’m running China and the U.S. just cut me out of selling or buying equipment, I am going to become self-sufficient in 10 years; that will be priority No. 1.
Ellenbogen: There was a Sputnik moment for the Chinese, where they made a decision that, while trade tariffs and tactics will go up or down, long term we need to be self-sufficient; we can’t rely on the U.S. supply chain.
Gabelli: On the bright side, as the leader of China, 40% of my GDP is consumer. The U.S. is 70% consumer, so if the Chinese consumer grows 10% a year, this is terrific. The rest of the economy is not going to grow as fast as in the past. If you are running that country, you’ve got to stimulate consumption, so that you can become more internally independent. And then you will be better able to deal with the U.S.
Mario, your investment firm recently expanded into China. Did you have problems doing that?
Gabelli: No. They’ll let you come in. I just opened an office in Hong Kong 12 weeks ago, because I see great opportunities. The Chinese are extraordinary—300 million people, or about 20% of the population, are going to be smarter and more focused on work than 90% of Americans. We are outnumbered. Learn to eat with chopsticks.
Cohen: This year will probably see U.S. GDP growth come in a little bit over 2%, and China, a little under 6%, so we are talking about real global growth around 3.2% to 3.3%. Earnings growth for equities is modest—not surprising, given the age of the cycle. In Europe, it’s something like 2% or 3%; the S&P, 5% or 6%; somewhat faster for Japan and the rest of Asia.
But I am concerned that the risks are asymmetric. The likelihood of getting returns dramatically better than that is less than that of getting negative returns. I just want to remind everyone who has been crowing about [U.S. stocks’] 31% total return in 2019 that there was a 20% decline in the last quarter of 2018. So, on a net basis, it was a 10% return.
forecast for the S&P 500 at year end is 3400. We are within spitting distance of that now; by most measures, the S&P is fully valued. I spend my time looking at what could go right and what could go wrong, and there are a lot more things on my “what could go wrong” list.
Bhansali: We’ve gone this entire morning without talking about the twin deficits in the U.S. At the peak of the GDP cycle and with record-low unemployment, we are still running deficits [on the budget and trade]. Despite that, the dollar has been strong. A lot of things are quite upside-down, yet the market has been very dismissive or blissfully ignorant. Sadly, when the market starts focusing on bad news, it comes out of the woodwork.
Cohen: I was getting to that as one of the potential catalysts for why interest rates could start to move up—and move up more than people expect. Now, rates may not rise enough to have a notable impact on economic activity—because we are talking about interest rates that are currently very, very, very low, and if they go up, then they will be just very, very low—but the impact on bond investors could be considerable. The only equity-valuation metrics which currently look OK are those tied to interest rates, and rising rates could therefore have a dislocating impact on stocks, as well.
Our economists estimate that the U.S. federal budget deficit, now over $1 trillion, will continue to increase—as will the deficit as a percentage of GDP—which is unprecedented for an economy that is growing. There has also been a very large increase in government spending at the federal level over the past two to three years. This deterioration in the budget balance can be attributed to a couple of things.
One, of course, was the 2018 tax cut. Most economists agreed that we needed some sort of corporate tax reform—Democrats agreed, Republicans agreed—but this wasn’t a true reform; it was a cut. We lowered our high statutory tax rate down to more global levels, but we didn’t get rid of all of the extra credits and loopholes. And so, the effective tax rate, which was already at global levels, has moved much lower in some industries. Revenues into federal coffers have gone down, and we haven’t seen that money being used to stimulate a great deal of business. The positive impacts of the tax changes lasted roughly four-to-six quarters but have now dissipated. It’s been disappointing.
Gabelli: In response, let me give you some numbers. In 2017, the cash flow from corporate taxes was $297 billion; these are Congressional Budget Office numbers. In 2018, it was $243 billion; in 2020, it is going to be over $307 billion. More important, the U.S. tax code went from global to territorial. There’s still more to do. A U.S. public company can’t deduct more than $1 million in compensation for a named executive officer. The tax bill failed to eliminate the carried interest [loophole for hedge funds]. Giving tax credits to rich people who are buying a Tesla—that’s crazy. There are details that can happen at the corporate level that can level the playing field.
Cohen: Goldman Sachs has looked at this, company by company, industry by industry. There are industries where effective tax rates have gone down dramatically, yet we have not seen a commensurate rise in long-term investment or in employment growth.
You do have modern monetary theory, or MMT. My personal name for that is magic money tree.
Can anyone paint a benign scenario in which debt-to-GDP in the U.S. comes back to more normal levels, or are we past the point where there is a credible, happy ending?
Cohen: There are two elements as to why the budget deficit is rising. One has to do with the cyclical forces and the tax changes and so on; the other, structural change, has to do with the aging population. As the baby boomers mature, two things happen: They earn less and therefore pay less in taxes, and they start taking entitlements. The peak of the baby boom was 1957; add 65 to 67 years to that, and early 2022 or 2024 brings a further increase in retirements—so the deficit-to-GDP would have been rising anyway. What’s unusual about the last couple of years is that without this significant demographic change and with ongoing economic growth, the deficit has gotten worse, due to the tax cuts and spending increases.
Now here’s the interesting thing that often doesn’t get discussed: You can figure out the coming impact of Social Security, but Medicare expenditures aren’t capped, and we have a very high rate of medical-care inflation. One positive is that with the implementation of Obamacare, medical inflation has come down. Not in all categories; pharmaceutical costs are high. The single most expensive year when a person is on Medicare is the last year of life.
Witmer: But you don’t know what year that is.
Cohen: True. Also, everybody assumed that the second most expensive year would be the year before that. It isn’t. It’s the first year of coverage, because many people who lacked adequate medical insurance were deferring medical care, for procedures such as joint replacement, diabetes treatment, ongoing care for cardiac issues. Following the implementation of Obamacare, we aren’t seeing that kind of surge when people go on Medicare, and the medical inflation number is actually down somewhat. That may be helpful in terms of the deficit.
Bhansali: Actually, that is the unsung technology hero across the U.S. economy. We focus so much on Silicon Valley and all the innovation we see as consumers, but the health-care industry has undergone enormous innovation—breakthrough, paradigm-shifting therapies, cures instead of chronic treatment for ailments.
Technology has also helped shift the cost burden from just acute care to chronic care; about $90 of the $100 you spend is on hospitalization and acute care, versus consuming a pill that keeps you at home, instead of the hospital. This is part of the reason inflation can be kept under control. In recent years, an amazing partnership has emerged in this country between the private sector and the government sector. The government has co-opted companies like
[UNH] into developing insurance programs like Medicare Advantage. They’ve been quite revolutionary in that they don’t even charge a top-up premium to Medicare recipients, yet give them very cost-effective benefits by negotiating better and by improving patient care via prevention, instead of cure. We don’t talk enough about this win-win development, but it is a very, very important undercurrent because it let’s us keep a lid on a huge expenditure by simply improving efficiency.
Desai: Can I go back briefly to your question on the deficit and debt, and whether inflation is the only way out? We underestimate the extent to which the U.S. has been doing exactly that in the post–global financial crisis world. It is the critical difference between the U.S. and Japan. Despite all the histrionics about deflation, we haven’t actually had any. Only one country has had a sustained period of deflation, and that was Japan. And, in consequence, its debt exploded. In the U.S., ongoing inflation has prevented debt-to-GDP from increasing more [than it has]. Inflation will pick up a bit. Long-term yields will go up a bit. We’ve had a massive increase in the deficit in the past year, and I am gobsmacked when I look at the policy proposals from some Democratic candidates.
You’re referring to ideas such as universal health care and free higher education, which no one has adequately explained how to pay for.
Priest: You do have modern monetary theory, or MMT. My personal name for that is magic money tree.
Desai: Modern magical thinking. What it comes down to is that a country that prints its debt in its own currency has no limit on how much debt it can print. The government, unlike all of us, doesn’t die, therefore, there’s no end point. The only constraint is inflation; but that’s a big one.
Priest: The theory is that deficits don’t matter. It sounds too good to be true. Look, when money is free, imagination is real. Some stocks have performed well, but their issuers make no money. In the Russell 2000, 600 companies aren’t profitable. Another observation: If you and your spouse are each 65, the chances of one of you living to be 90 is almost 100%. How you are going to finance age 65 to 90 with no earned income? That is a big worry. Income replacement is the biggest need and opportunity in the investment industry.
Desai: People always point to Japan over the past several decades to justify the case for low and even negative yields forever. The key difference with the U.S. is that Japan had deflation for a large part of that time, and real rates in Japan were actually higher than real rates in the U.S. currently, which are negative. Real rates in Japan were strongly positive for much of the two decades post-1990. To take the leap from Japan’s experience to assume that the Fed can keep printing money forever is a problem. It is very seductive to populist politicians, and that’s one of the reasons it gets me really nervous. I debated Stephanie Kelton, who has become the face of modern monetary theory. She feels the choice between universal health care, forgiveness of student loans, and increased spending on infrastructure is a false one, because, in fact, you can have them all. It’s a problem to assume that the U.S. has no budget constraints; it does.
We should not underestimate the magnitude of regulatory changes that can take place, even with a split Congress.
Isn’t the flip side of MMT the idea that you can keep cutting taxes, and everything will be fine?
Black: One of the things that has changed over the past few years is that the Republicans are no longer deficit hawks. Cutting taxes has never expanded the receipts. Ironically, the lowest debt-to-GDP in the modern era, at 37%, was when Jimmy Carter left office. The next time was late in Bill Clinton’s second term, 55%. Today, it’s 107%. There doesn’t seem to be any fear on either side, or impetus to do anything about it. I don’t think we can ever work our way out from that.
Let’s talk about the election. Abby, you made a pretty good case for Michael Bloomberg as a candidate last year, although you doubted his electability. Now that he’s actually in the race, what are your thoughts?
Cohen: I’m not a political analyst. But the two candidates I like from a policy perspective and who could have appeal in the middle—that’s where the game is played—would be Mike Bloomberg and Amy Klobuchar. The game is also played in terms of a very small number of states. As a voter in the state of New York, my vote doesn’t matter as much. Perhaps I should move.
Gabelli: Don’t go to Florida; the New York Republicans need that vote.
Cohen: Current surveys suggest that the House will remain in Democratic control, and the Senate in the hands of the Republicans. It is pretty much a toss-up in terms of a Democrat versus Republican win in the White House. Trump remains very popular among Republican voters, but many independents have now moved away, and it is not clear where they will go until we have a Democratic nominee. The other thing that throws this up in the air is the impeachment; we are hearing that there may be other impeachment counts waiting in the wings, such as the president’s use of war powers. That could further muddy these waters.
Do the rest of you agree? Who do you think will—or should—be on the Democratic ticket, who wins the election, and which party takes the Senate? Bill, you’re up.
Priest: The most formidable Democratic ticket would be Joe Biden, with Klobuchar for vice president. They probably lose to Trump because of the electoral college effect.
Black: It would take a moderate like Biden. I like Amy, but I don’t think she is a realistic nominee. Otherwise, unfortunately, Trump gets re-elected. Among the states that are in play are Michigan, Pennsylvania, Wisconsin, North Carolina, Virginia, and Nevada; those are the battleground states. As Abby alluded to, there has been a big shift, and the people who might have voted for Trump last time are moving in the other direction. But I’m afraid Trump wins.
Witmer: It’s interesting you say that, because I hear many people say, “Oh, I didn’t vote for Trump last time, but I will this time.” But I live in a red state.
Ellenbogen: Warren’s numbers started to fall precipitously when she put some definition around universal health care—people realized it was a tax that they weren’t willing to pay. The markets will become nervous if the nominee is either Warren or Sanders. Warren would be worse than Sanders [for the markets].
Why? Because she could actually get things done?
Ellenbogen: She actually taught me in law school. Yes, she would be a more effective executive, whereas Sanders would be viewed as someone who would be largely ineffective as president. I’m not predicting that either of them will be the nominee. The nominee is likely to be Biden or perhaps Bloomberg, if his strategy of skipping early primaries works.
Witmer: If Biden drops out, Bloomberg has a shot.
Ellenbogen: Right, or some would say Bloomberg has shifted the conversation and may actually be helping Biden. Either scenario is positive.
Can either one beat Trump?
Ellenbogen: Trump wins if the panel is correct about the U.S. economy—unemployment is low, wage growth is high. The other thing I find is that the U.S. tends to be politically aligned with the trends in the United Kingdom. We saw Boris Johnson win in a landslide. Trump is not going to win in a landslide because of his personality issues; he doesn’t represent a lot of U.S. values to the electorate. If a Democrat wins. and the Democrats take the Senate, that would basically reverse a lot of the policies that have been viewed as pro-market over the past four years.
If the Democrats don’t win the Senate, how much would really change? Wouldn’t the markets assume gridlock?
Desai: One element that has been really under-remarked is what this administration has achieved via executive order on the regulatory front, which has had an important impact. We should not underestimate the magnitude of regulatory changes that can take place, even with a split Congress.
Ahlsten: Three years ago, we all said that if Trump were elected, the market would crash. It ended up being a really strong market, and, for the most part, the economy has been good for most people.
This whole market problem [of what happens if] extreme left or Trump [gets elected] starts to solve itself, because the polls almost straight-jacket how far a policy can go. When Warren got traction with Medicare for All, people started to pump the brakes and move in a more centrist way.
[The election] will be contentious; it will be emotional; there will be some volatility—but at the end of the day, there will not be a big market event. If the economy is strong, and the markets hold up globally and we haven’t started another conflict that’s too extreme in the Middle East, Trump has a better than 50% chance of winning. I know most of my ESG [environmental, social, and corporate governance] investors probably don’t want to hear that.
Cohen: We keep talking about Iran and the Middle East. No one, except me, has mentioned North Korea. It could potentially be a disaster for East Asia and nuclear weapons controls in general. We need to keep that in mind.
Gabelli: It really comes down to the next 90 days, with regard to how we react to how the Iranians react to the elimination of Maj. Gen. Qassem Soleimani. It could have an impact on the economy. If the economy stays the way it is, Trump is going to win again. The Iranians have to do something for political reasons. So what would they do? If I were them, I would do a cybersecurity attack on American infrastructure, particularly on the utility grid, and let’s see how they react. The American utility power structure grid is highly vulnerable to a cyberattack.
If the economy stays the way it is, Trump is going to win again.
Since you invest in such long-run themes, James, which of these geopolitical factors matter the most to you?
Anderson: The issues surrounding the rise of China are so much more important. Anything else is a distraction.
Desai: The idea that the U.S. is somehow going to move back to a pre-Trump world in terms of trade is highly unlikely. Based on what various Democratic candidates have said, they are going to have more intransigence on trade. Trade is something we should be careful about—either running a victory lap or not.
What are some of the opportunities investors could miss because of the increased U.S.-China tensions?
Anderson: One of the things that has intrigued me the past 12 to 18 months is that some business models that are not working in America are working elsewhere—including China, because of the scale there.
There’s been all this publicity about food-delivery services—like
[GRUB] with its disastrous stock performance—not working in America. Last quarter,
delivered 457,000 meals a day. The equivalent figure from China’s
[3690.Hong Kong] is just under 28 million.
China’s urban population is approaching one billion people. Based on this trend, the eventual size of that market is about one trillion meals a year. What these superapps in China are doing is effectively providing a way to navigate a society of enormous scale and complexity that has a large number of cities with over a million people.
So a big risk for you is missing out on these platform companies in China?
Anderson: The scale and pace of what’s happening in China are beyond anything in America. We cannot dismiss China and say that this is a nasty communist-driven society. It’s a country—a system—that has pulled 600 million people out of poverty, and where life expectancy and education levels are still rising. We may all like the idea that you need a liberal democracy to get economic development, but I’m not sure it’s true. Both America and China are deeply capitalist societies; theirs is a different model of capitalism. Now in China, you may become a politician first and then make money. In America, it tends to be the other way around, but I don’t think having this tone of moral superiority to China is very sensible.
Will some Chinese business models gain ground in the U.S.?
Ellenbogen: To over-generalize, Europeans are slow to innovate for a bunch of reasons. There is a mentality similar to what you see for the German automobile, where the consumer wants a really elevated, refined experience, and is less willing to try new things. The U.S. is willing to deal with some mistakes and products that aren’t perfectly tuned. The Chinese consumer is the extreme, looking for the new way to do things. The mentality to embrace innovation quickly is unique to China.
Look at what’s going on in payments in China, with [
] Tenpay and Alipay. You basically do not use cash or credit cards in China. In 2018, Tenpay had over 900 million active users, and Alipay had 600 million. China is the north star for what’s going on in the change in financial payments globally. If you look at the potential next platforms in technology, whether they are going to be driven by artificial intelligence or quantum computing, most people would say it is very much a competition [between the U.S. and China].
China has two advantages: First, the state is deeply funding [technological development], while we are relying on companies to do it. If we over-regulate Microsoft and Google, it will limit their abilities to fund these areas, which is important for us to be competitive. Second, the Chinese are able to analyze much bigger data sets much faster, because they don’t have to deal with the [privacy, regulatory, and other] issues we have. It is vital to understand what’s going on in China if you want to invest in a global industry.
Write to Beverly Goodman at firstname.lastname@example.org