MASTERCLASS: Liquid Alternatives - May 2019
May 3, 2019
Hoda Emam: As we edge closer to the end of a particularly volatile year, it's important to reflect on what investors experienced, and what market developments we can anticipate in 2019. Is the Federal Reserve raising rates too much, too fast, could the ongoing U.S./China trade war bring about a recession? And it looks like we'll be seeing a potential hard Brexit, versus a more cooperative Brexit. Could it cause a global slowdown?
Hoda Emam: Today I'm joined by three experts who will share their insights on the state of the economy in the coming year from the NASDAQ Entrepreneurial Center in San Francisco, welcome to the 2019 Global Outlook Masterclass. We have David Dali, portfolio strategist at Matthews Asia, Jim Bell, president and founder of Bell Investment Advisors, and Terry Goode, senior portfolio manager at Wells Fargo Asset Management.
Hoda Emam: So, let's go ahead and jump right in. How would you characterize the market of 2018? What have investors experienced this year?
Jim Bell: Investors have experienced a lot of disappointment, actually. 2018 has been just the opposite of 2017, which virtually had no volatility and the market pretty much went straight up, based on that euphoria about what the Trump Administration could do with tax cuts and deregulation. We started 2018 with a giant leap forward in January, so that trend was continuing, and personally, I think when President Trump started threatening and got serious and started making plans to execute tariffs, that's when the market really slumped in February. And we've had a lot of volatility. Not excessive volatility, but compared to 2017, just a lot more volatility and disappointing for equity investors here and around the world.
Terry Goode: I guess, I'd add for the municipal bond market, actually it's been a good year relative to other asset classes. Not the best year for municipal debt, but still better than equities, better than treasuries. And actually, if you went down in credit quality and were shorter duration, you actually did even better. High yield municipals did really well. They're up over four percent. That's largely due to Puerto Rico bonds doing well, tobacco settlement bonds doing well, and largely due to a strong technical backdrop with low supply and strong demand.
David Dali: Well, for Asia and broad emerging markets, it's pretty much been a perfect storm. We ... Like Jim was talking about, we had a stellar 2017 in the marketplace and in 2018, the two largest economies in the world were in tightening mode. And that was certainly a headwind for markets. Secondly, the U.S. dollar was certainly strong against most of our currencies. The price of oil was really high, which was certainly a headwind for many Asian economies. And lastly, trade and trade controversy certainly helped with poor sentiment and fears of a global slowdown. So, all contributed to what was a fairly weak 2018.
Hoda Emam: All right. So, going into 2019, what are your predictions for equity and debt in markets in the coming year?
Jim Bell: So, the challenges, as we've talked about, this whole tariff dynamic is not good for business. It's a tax on consumers. And whenever you tax something, you get less of it, so it's a tax on commerce and we're seeing downward pressure on trade and business in general, just is not helpful. The other issue is how accommodating is the Federal Reserve gonna be.
Jim Bell: We have a big meeting tomorrow, and it's gonna be the most viewed press conference maybe in the history of the Fed. But from our point of view, we have still historically low interest rates, inflation is being very tame, wage growth is at a ten year high at 3.1 percent. And the unemployment rate is at a 50 year low. So, that kind of strength and momentum, we feel, is gonna carry into 2019 if we can get some resolution on the China trade war, and the Fed keeps going in the direction I think it is with flexibility and being data driven. And I think we can have an up year.
Jim Bell: Another statistic is that since 1945, there's been 18 midterm elections, and all 18 of those, 18 years in a row, the year after a midterm has been positive with an average return in the S&P 500 of over 19 percent. So, we may break that winning streak in 2019, but we have some history on our side.
Hoda Emam: Oh, that's interesting.
Terry Goode: The municipal market, we expect it to be positive in 2019. We think supply will be up after a down year in 2018. We expect demand for muni's to be fairly strong. Yield levels are attractive. Some of the things we're keeping our eye on are the some of the same things you mentioned. We're looking at a global slowdown. We start talking about a hard Brexit rather than an amicable Brexit. We're seeing Italy still weak, even though they have a possible deal today. We talked a little bit about the tariffs and trade wars and that impacting growth. And also, the Fed, we think the Fed may be closer to a pause, and we think when you look at our yield curve, our yield curve probably reflected at least three to four increases next year. And with the Fed pausing, we're gonna likely see maybe intermediate to long-term rates maybe have peaked. So, we think a fairly good backdrop for the municipal market.
David Dali: I mean, I'd love to add from Jim and Terry, at the end of the day we're fairly sanguine for next year. Fairly optimistic. Really given from where we are today, we think that markets in general have priced in quite a bit of risk overall. Some of those same clouds from the perfect storm tend to be dissipating. From our perspective the Fed is in the second half of it's tightening cycle. So, we don't see the same type of resistance going forward. The same with China. Currencies have already depreciated somewhat, credit spreads have already widened somewhat. So, all these headwinds are slowly becoming neutral to tailwinds, and that bodes better for 2019 in our universe.
Hoda Emam: So, David, what are some catalysts for an EM rebound?
David Dali: Well, certainly there's plenty. As I mentioned before, some of these headwinds are certainly turning. And that's a big deal. I mean, the fact that monetary tightening in China and the U.S. are largely behind us, that's good for corporates and corporate earnings. So, certainly earnings, from our perspective, are on very strong footing. I mean, at this stage, investors really derated international equities, especially those in emerging markets and Asia in 2018. And that derating has created valuations that are somewhat attractive today.
David Dali: So, although valuations may not be a catalyst, things like lower tightening bias is a catalyst. Things like currency strength, and lack of current dollar strength as a headwind, is a catalyst. Things like lower oil prices for most of our countries certainly helps fiscal governments and fiscal governments help stimulate economies. And lastly, there's ... If we're wrong, and there's a bit of a hiccup, the Chinese government has all the wherewithal and the power to stimulate their economy and help dampen what is a down side. So, plenty to look forward to in 2019, but plenty of catalysts.
Hoda Emam: Okay. Jim, Terry, did you guys want to add anything?
Jim Bell: I would just add, David and I were talking earlier that in the emerging market space, and international markets, and the U.S. market as well, valuations are a lot kinder. So, if you have value investors or value managers that focus on that, for long-term investors, it's a good time to jump in.
Terry Goode: Yeah. The only thing I'd add is we look to emerging markets to sometimes get a direction of where spreads and trends could go in the muni market. So, when we start seeing volatility in emerging markets, and wider spreads, we start thinking about going up in credit quality or decreasing our credit waiting.
David Dali: I mean, to along that point, Terry, I mean, credit spreads and EM, we started this Fed cycle in and around 300 basis points. Now we're up above 400 basis points, which certainly, I'm fairly optimistic in credit markets and EM as well. I think we're being well compensated for the risk these days. So, pretty benign environment in credit as well. I mean, I wish when I was in my 20s and 30s that a financial advisor would tell me whenever we get to that six, six-and-a-half, seven, eight percent yields, those are really attractive yields, and quite strong compounders of wealth. So, that's the position we're in today.
Terry Goode: Yeah, it's great. It's a little different than the municipal market. Our credit spreads, although they've widened a little bit starting in October, they're still near the tights in credit spreads, and so we're not getting compensated we think, for going down in credit quality, so we're actually going up in credit quality for new purchases, not necessarily selling our credit, but we really don't feel like we're being compensated. So, we would tell investors who can to buy corporate credit down short and buy munis out long.
Hoda Emam: Okay. Any favorite themes in emerging markets going into the next year?
David Dali: Well, there are plenty. I mean, the two that certainly make sense to me today, certainly I'm a big better on the consumer. Not only has the consumer done well, this is a theme vis-à-vis general emerging markets, but there's a lot of benefits. I mean, the consumer, if we're all wrong and things kind of go sideways or downward, the consumer and the consumer stocks in general have a beta of about 0.6 and 0.7 versus the market, so they do tend to dampen volatility quite a bit. So, the consumer to me, not only does it have all that middle class growth cache to it, the rising of the middle class cache to it, but it also has some asset allocation benefits as well. So, certainly that's one theme.
David Dali: The other theme, a lot of Wall Street that I'm reading, they're really favoring value versus growth. And I just don't necessarily agree. I mean, today a lot of our growth stocks have been hit over the last year. Global growth scares because of the China trade situation. And growth has gone down and is rerated, so we prefer to find quality growth companies at a discount, is a great theme today.
Hoda Emam: Okay. Jim, did you want to add anything?
Jim Bell: No. I do think the valuations offer good values. So, it's an entry point, as long as you can tolerate volatility and risk, which you have to do to be a successful investor.
Hoda Emam: Okay. Terry, looking at munis, what opportunities exist in 2019 when it comes to municipal bonds?
Terry Goode: Well, in general, we like munis going into 2019. I mentioned earlier that we are going up in credit quality for most of our new purchases. Not that we're selling any lower credit quality, but we just feel like upping credit quality is prudent. We're also extending duration. We do think rates are gonna be range-bound just because of the global growth concerns that we've been talking about. Talking about the Fed possibly pausing. We do think the Fed will likely move tomorrow, but we do think the press conference will talk a lot about a possible slow down in those hikes. So, really think munis are poised to do well.
Terry Goode: Historically, we've liked Illinois, and New Jersey bonds. Both Illinois and New Jersey have had pension issues, but our strong credit research team have been able to guide us and help us pick the right credits. I think going forward, we'd likely probably take more of our exposure down the curve on those names, just because of longer term pension issues.
Hoda Emam: Okay. Any macro trends you're closely following?
Terry Goode: Well, macro trends, really again we're talking about a hard Brexit. We're watching that very closely. We're looking at what's going on in Italy, we're looking at France with the protests going on there. We're looking at a slowdown in China. And so, really, those global trends impacting kind of the level of rates going forward, so we feel like again, extending duration and buying up in credit quality. Good opportunity.
Jim Bell:I would just add that one of our successful strategies at Bell Investment Advisors, we call it stable growth. So, it's an asset allocation strategy and we depend on the bond market to quite an extent, and as Terry was saying this year, that's helped in the portfolios that certainly the muni market and the bond market in general has been relatively so stable compared to the stock market. That our investors have appreciated that.
Hoda Emam: David, did you want to add anything?
David Dali: Not really. I mean, I'll jump on the bandwagon when it comes to fixed income. I mean, certainly, without the headwinds of rising interest rates, then you're left with coupon and credit spread. So, in both those cases we find it to be fairly valued and could be quite good value for investors, whether it's in emerging markets, or Asian in particular, even in U.S. credit.
Hoda Emam: Okay. Jim, what's keeping investors up at night? What's worrying investors, and how could we potentially resolve some of those worries in 2019?
Jim Bell: There's three or four things. The first one that comes to mind is that there's been a lot of press and discussion of have we seen the top of the mountain, and is it all downhill from here? Is this as good as it's gonna get?
Hoda Emam: But that's always a worry, right?
Jim Bell: The peak earnings question. I think one of the ways that we've talked to our clients about that is that what we know from history, with the U.S. market and the economy, is every time the U.S. stock market hits a new high, historically, it's always, eventually sometimes in the short term, sometimes longer term, it's been able to surpass that high. So, a new high is not a time to stop or get out. History just shows that on a long term, being worried about those peaks is not constructive. So, it's much better to keep that long term perspective.
Jim Bell: The second worry, as I mentioned earlier, is the Federal Reserve. And are they ... If they make mistakes, if they keep raising interest rates in spite of what data is showing about potential slowing and just headwinds for the market, that's another concern. And I think there's good news on that front in terms of what the Fed's been communicating about backing away from this preset dot plot to raise rates every quarter. So, I think as Terry mentioned, we don't see ... They're backing off from as many rate hikes in 2019, and they're talking about a pause so, to wait and see. So, that's very positive.
Jim Bell: And then the trade war with China has not been constructive. Europe's fragile, the Brexit's very messy, a point right now, so that's ... As Europe is already fragile, this is just another kick while it's down. So, resolving that and the trade dispute are really key to what 2019 is gonna bring. And we're seeing some accomodation on China's part, and so hopefully there will be some flexibility and some real dialogue and actions taken.
Jim Bell: The final thing I would say that bothers a lot of our clients is that President Trump is not a team player. He's torn up a lot of teams. He got out of the Trans-Pacific Partnership, which I think was a mistake, he got out of the Paris climate environmental accord, he got out of the Iran nuclear agreement, so this mantra that he alone can fix it, is not constructive. And we'd be in a lot better position if we were in dialogue with China as a group, as a block. Every trading partner with China suffers the same issues that we have about stealing technology, international property is not protected, so teamwork is a much better path forward than the path that this president continues to take. And so, there's a lot of concern about that.
Hoda Emam: Great. David, Terry did you guys want to add anything?
David Dali: Well, I'm jump on to what you just said at the very end in talking about China and acting as a team. I mean, I hope our administration realizes that China, yes, we have a bit of a trade deficit with China today, and we seem to be buying a lot more products than we're selling to them, but you have to look forward ten or 15 years. I mean, the Chinese economy will be as big as the U.S. economy in 15 years, and they will be one of the largest importer of U.S. goods. And to the extent, the sooner we can figure that out the better, because we are certainly gonna be very, very linked trading partners. And China will be importing massive amounts of U.S. goods into their borders. And so, we need to work this out. It's almost too big to fail, and we need to have a resolution.
Hoda Emam: Yeah.
Terry Goode: Yeah, only thing I'd add, I guess, big budget deficit here in the U.S. Really rare to be raising interest rates with such a big budget deficit. So, any sort of uncertainty from a fiscal standpoint, also impacts our market, the municipal credit market. Drilling down in munis, I would say what I'm hearing is people are concerned about late cycle deals that have gotten done in our market. There was a really ... a search for yield with rates being so low, and so a lot of speculative deals were getting done in our market at you would think would be decent credit spreads, but those credit spreads have actually started to balloon out a little bit.
Terry Goode: And the way these deals are structured, they're issued with a certain capitalized interest period. So, the principal and interest is paid from the bond proceeds for the first 18 months to two years. We're seeing projects approach the end of that capitalized interest period. And so, we're worried about those projects coming online and not hitting their feasibility or projection. So, one of the reasons why we're going up in credit quality in terms of the new deals we're buying.
Hoda Emam: Okay. Well, when it comes to future economic conditions, is an inverted yield curve on the horizon?
Terry Goode: Well, I guess we're close to that. We're flat on the front end right now. We hit days of inversion there. But I guess we have not necessarily hit a true inversion, as you would speak of. I think what that's telling you is that market participants are thinking Fed should be closer to pausing a bit. The Treasury curve is extremely flat. You look at the muni yield curve, very steep. It's 140 basis points right now from one year to 30 years, so that's one of the reasons why we're constructive on munis and that really steep yield curve and buying out the curve, higher credit quality.
Hoda Emam: Okay.
David Dali: From our perspective, it would take a lot to get a full inversion of the yield curve. And I'm not quite sure what that would mean for emerging market and Asian investors anyway. I mean, certainly a flat yield curve is close to where we are today. If you ask me does that indicate recession is imminent? Certainly in our world, in emerging markets and Asia, we don't see recession. We don't see a recession in China. Any of our fast growing, larger economies. India, Indonesia, any place like that. So, we're pretty far away from what a flat U.S. yield curve would mean in other economies. I think it means very different things.
Hoda Emam: Okay.
Jim Bell: If you look at the history of yield curve phenomenons, even when there has been inversions, there's a long lag time before in most cases by far, before the recession hits or before we get into a bear market, so. And another point is that with the quantitative easing that's a historical phenomenon that's brand new here in the United States and around the world. There's thinking that the yield curve is not a good predictor coming out of recovering from quantitative easing and trying to return to normal interest rate patterns.
Hoda Emam: Do you think the Fed would even allow that to happen?
Jim Bell: It would be ... I can't see them ... I guess, like David said, we haven't hit a ten and two year classic yield curve inversion. Let's talk about this, one of the solutions would be to lower interest rates on the short term so it would create a steepness, but that seems a little far fetched to me that we're ready to start reducing interest rates. I think it would take a pretty cataclysmic series of events to get there.
Terry Goode: Yeah, but I guess I would think that the Fed would not allow it. I think they would be very well aware of implications for a true inversion.
Hoda Emam: Yeah.
Terry Goode: And we would expect the Fed to act to prevent that from happening.
Hoda Emam: Would hurt investor confidence.
David Dali: Yeah. Definitely.
Terry Goode: Yes.
Hoda Emam: To say the least.
Terry Goode: Yes. Exactly.
David Dali: Definitely.
Hoda Emam: All right, well. Jim, staying with the Fed, is the Federal Reserve raising rates too much, too fast?
Jim Bell: I believe they're doing it just right, actually. The getting back to normal is a really important project, and that's been their challenge. I've been very heartened by their change in communication. I think it was in October, Chairman Powell said we're a long way from neutral and that really spooked the markets, getting back to his dot plot, they're gonna keep raising rates every quarter. So, I'm encouraged by them talking about pausing, being more flexible, being data driven, really studying the data. There was a remarkable editorial in the Wall Street Journal today, advising the Fed to not raise rates tomorrow. To take a pause. And they even outlined what Powell's message could be to counteract the problems President Trump has created by just criticizing the Fed constantly and they shouldn't be raising interest rates. If Powell could make a comment that this was data driven, we're pausing because of the economic data. It has nothing to do with politics.
Hoda Emam: Mm-hmm (affirmative). David, did you want to add anything?
David Dali: Yeah. I mean, my guess is that 2019 will be much less of a U.S. interest rate story. I think that story was largely a 2017 and 2018 tightening story, and it could be that that narrative fades a bit in 2019 as we get more of a neutral stance, which in emerging markets and Asia, we welcome. Because what happens when the Fed goes on a trajectory, other central bankers have to go on a similar trajectory at some way, shape, or form. So, if you're a central banker in India, or if you're even one in places like Indonesia, if you don't want your currencies to devalue much against the dollar, you have to slowly get on that same trajectory. And it becomes very difficult to manage their monetary policy. So, a stable U.S. Fed is good for us all.
Terry Goode: I would agree with that. I think one thing of importance to note is that, I believe there's a press conference after every meeting now, so we're live on every meeting, right? So, I think that may inject a little bit more uncertainty into the market because typically, usually we don't have a Fed move without a press conference. So, going forward, we may see a little bit more uncertainty, and there's definitely-
Hoda Emam: That's a really good point.
Terry Goode:... Unfortunately, too much talking about the Fed. I think from the fiscal, from the administration, I think that puts the Fed in a tough situation to have that ... The headlines around it, so. But, I guess backing up, we do expect the Fed to move tomorrow. I think if they didn't, I think that my inject ever more uncertainty into the market.
Hoda Emam: All right. Terry, what kind of consideration should investors give to duration risk given the current economic backdrop?
Terry Goode: Yeah. Great question. I think for us, we are extending most of our portfolios. And we entered 2018 short duration, which was the right call. So, it's not necessarily that we're very bullish, but we just have the room to extend a little bit. Our curve is steep, so there's good opportunities to buy for those longer portfolios out in the 20 to 22 year range. It's a good place for the roll down for shorter portfolios, the seven year range. I think it's constructive. And also, a lot of the things we've talked about today in terms of just global growth concerns, I think that's gonna weigh on rates, and that's gonna keep us in an interest rate environment where extending duration is prudent.
Hoda Emam: Okay. Did you guys wanna add anything?
David Dali: No, I just go back to the fact that that type of outlook is good for equities as well. Right? You have a stable yield curve when you have a flattening of Treasury restoration, I think that's good for us all. It really supports equity market as well. Especially in emerging markets.
Hoda Emam: Okay. Staying with emerging markets. What could cause emerging market assets to under perform?
David Dali: Under perform?
Hoda Emam: Yes.
David Dali: Certainly not the base case for next year, but since you asked, I think any type of growth shock, true growth shock to the global economy. If we're all wrong and the Fed does stop hiking rates for a very good reason, the U.S. economy starts to roll over, whether it's because of a hard Brexit or some other catalyst for much slower economic growth globally, that hurts EM. I mean, certainly that can hurt EM, that will cause shocks and fears about a Chinese slowdown, which will hurt broader Asia, and certainly broader EM. That's probably the biggest risk that we have, is this growth shock. Because what happens is, you have a growth shock, and then you have a credit shock. Credit spreads wide and corporates it becomes much harder to finance the roll over the debt, et cetera. And it's just a trickle down. It's a ladder effect. So, that would be the biggest risk we have. That would be a [inaudible 00:29:07] run performance.
Hoda Emam: Okay. Did you guys wanna ...
Jim Bell: I was just gonna say, yeah, globalism is not gonna go away. And it's the thing that was so healthy about 2017 and part of 2016, is all the economies were growing in a synchronized pattern. It was very historic and very healthy. And that's what we want. We want all countries to be doing well at the same time as much as possible. That just creates more trade and commerce and better pricing for consumers. So, I agree, it's just important to these America first or Britain first populist tendencies are contrary to that. And it's important to overcome that.
Hoda Emam: Okay. Terry, where is your team finding opportunity on the curve?
Terry Goode: Yeah. So, our municipal yield curve is steep, relative to the Treasury curve. 140 basis point. So, going out to the steepest part, on the long end, 20 to 25 year part of the curve, really good and attractive part of the curve to buy. For those shorter portfolios that can't extend, seven year part of the curve. Also, speaking to the 30 year part of the curve when you look at muni to treasury ratios, they're in excess of 100 percent. So, cheap, a good opportunity. And part of the reason is because banks have not been buying munis out long due to corporate tax reform. So, the attractiveness of munis is not necessarily there. But we do think with cheap ratios like that, there is an opportunity to buy that 30 year, and I think you'll be rewarded.
Hoda Emam: Okay. Did you guys want to add anything on that?
David Dali: No.
Jim Bell: No.
Hoda Emam: All right. So, what market developments will occur in 2019 that will define where we are in the credit cycle, and also in the economic cycle?
David Dali: Tough call for me. I mean, at the end of the day, if the base case is there and the U.S. comes off it's really high rate of growth, instead of growing 3.2, 3.5, maybe it settles in at two-and-a-half, two-and-three-quarters, that's almost a goldilocks scenario. At that point, most emerging markets, most other developed markets are kind of on that stable growth trajectory. And that to us is a very benign, a very solid scenario. So, if that's the case, I think we're all in pretty good shape. There's not a lot of controversy.
Hoda Emam: Okay. And Terry, in terms of credit quality, what are you seeing as the best opportunities?
Terry Goode: Well, based on where credit spreads are right now in the muni market, we think higher credit quality's better. We're not necessarily selling our lower credit quality, or we just think for new purchases, we're not getting paid to go down in credit quality. We look to other markets to see where credit spreads could possibly go in the muni market. And so, when I talk to our corporate high yield guys, they're actually buying more true corporate high yield, they're not buying leveraged loans because of concerns about credit there. We talked a little bit earlier about emerging markets and where those credit spreads are. So, our credit spreads in the muni market have widened somewhat, but I don't think they've widened enough to compensate us for going down in credit quality to the no-rated or double B, so we think A or better upping credit quality is where we want to be right now.
David Dali: From our perspective, we're happy to go into lower credits, we're happy to go into that sub-investment gray credit area. We think that, especially when it comes to Asian credit, Asian credits weren't a big beneficiary of quantitative easing to begin with so a lot of the European, and maybe even U.S. high yield markets really did benefit. And so, some of those credit spreads really got quite tight. And even on a historical basis, maybe they still are a bit tight. But Asian credit, certainly more along the lines of the historical averages. And so, not nearly as stretched. So, we're happy to go sub-investment gray, in fact, in that six, seven, eight percent overall yield level, we're pretty comfortable. Especially if you're right and inflation's gonna be somewhat benign in the long end of the curve, especially in the U.S., is fairly flat, we're okay with extending in credit quality, bringing it down a bit.
Terry Goode: Yeah, again, for our clients that can buy corporate and munis, we're seeing buy that corporate credit down short, but buy munis out long. So, there are opportunities in corporate credit as well.
Hoda Emam: Okay. And David, if the U.S. stock market continues its decline, can emerging market equities perform well, or do better than U.S. or other developed markets?
David Dali: That's a great question. I mean, at the end of the day, so many investors ask can EM and Asia actually outperform in the U.S. is going down. That's a great question. And the answer is, historically there are instance where the EM actually does outperform. I mean, between 2000 and 2003, there was EM outperformance, very recently between in years 2016 and '17 they're outperformance. It's typically after the U.S. market has a really good run vis-à-vis Asian and emerging markets that we tend to do better in subsequent years. So, there's certainly a precedent for EM outperforming, even if the U.S. flattens out or turns down. There is a precedent. And going into next year, there's a bit of set up for that, so again, if the U.S. comes off it's tax hike high and certainly and growth kind of flattens out at two-and-a-half, two-and-three-quarters, there is certainly a scenario where EM economies and the growth differential between EM economies and developed economies actually widens. And it's in during those circumstances that EM can outperform. So, it could be we're setting up for that next year.
Hoda Emam: Okay. Jim, I feel like you wanna ...
Jim Bell: Yeah.
Hoda Emam: Offer something.
Jim Bell: I'm just gonna add that should the United States experience kind of a peak in interest rates where the Fed pauses and we kind of stabilize at two-and-a-half, two-and-three-quarters percent on the Fed funds, then that's gonna take some of the wind out of the strong dollar. So, that the dollar will lose some of it's strength, which certainly helps our export industries. And it'll also help emerging markets because they have debt denominated in dollars and they have to use more of their currency to pay off the debt when the dollar's strong, so that dollar weakening would be good for the United States and emerging markets.
David Dali: That's right.
Hoda Emam: All right. Let's move on to Asia. Can the U.S./China trade war bring about a recession?
David Dali: Well, I'll jump in from the Asia side. It can't bring about a recession in China or in broader Asia. I mean, growth is just too high. So, you're not gonna get to a technical recession in China, when China's now growing at six percent. So, a lot of estimates I heard, even a full blown trade war where we come 60 days from now if Mr. Trump implements 25 percent tariffs across the board on imports of Chinese goods, the high estimates I've heard it it's gonna dampen the Chinese economy by one, one-and-a-quarter percent. So, yes, that's a meaningful hit to the Chinese economy, but certainly not recessionary. Here in the U.S. might be slightly different, but I don't think it's recessionary. But I'm happy to throw out to you guys.
Jim Bell: Yeah. I do think the disruptive experience of the tariff threats and the tariff executions and the trade wars has really taken the wind out of the U.S. economy. As I said earlier, it's really bad for U.S. consumers. The costs keep going up. And I'd like to say, too, that trade deficits are not the enemy. That's a very misguided principal that President Trump has grabbed onto. Trade deficits, they have been great for American consumers. We've experienced such great value coming out of China, the things they produce best like clothing and footwear, so it's just a very misguided principal. I have a trade deficit with my grocery store, it's not bad for me, it's good for me. I love their products and their efficiency, and I think it's similar on a global stage. That trade deficits just mean that nations get to build and produce what they produce best, at the most efficient cost, and the whole world benefits.
Hoda Emam: Yeah.
David Dali: If there's free trade.
Jim Bell: Yes. Yeah, that's ... There are other issues, but the way it's being approached by this administration is not constructive.
Hoda Emam: So, is there a way for this sort of tit-for-tat war to be avoided?
Jim Bell: Well, I think what's happening in the U.S. market now, where we're negative for the year, we're at a low for the year, it's stalking the administration. I mean, it's punishing the administration. And Trump's been very fixated on taking credit for the stock market. So, I think, just like he's backed off from the five billion he was demanding for the border wall, I think if this pain continues, he'll get moving and he'll accommodate, he'll reduce the trade tensions and wanna make some deals with China and other nations and stop the tariff madness.
David Dali: No doubt in my mind that there'll be some concessions along the way. Can it be avoided? Not sure. I think we're pretty far down the path of some type of trade controversy. So, there'll be some compromise along the way. What I do think can be somewhat avoided though, is the overall economic impact. I think certainly in the case of the Chinese, there's a lot of tools they have in the toolbox to help mitigate the slowdown of their economy if there is a full blown trade war. If it does mean that they're gonna be exporting less, the Chinese government will pull rabbits out of their hat. They will stimulate, they will offer subsidies, they will do what they can to soften the blow. So, that's what I mean. At the end of the day, even if we do see an escalated trade scenario from where we are today, there's a lot of things that both governments can do to soften the blow.
Hoda Emam: So, David, do investors own too much or not enough of China?
David Dali: Huh. Now, that's a loaded question. I don't know about you guys, we're all about together the same age, so I can tell you there's a lot of woulda, coulda, shoulda investment moments in my life. I should've boughten that stock, or that house, et cetera. I think when it comes to China, 15 years from now we're all gonna look back and say, "We should have bought more China." It's not just because of the stories about the fast growth, the nominal growth of China being nine, ten, 11 percent per year. Or that middle class rising. It's not just that, there are technical reasons. I mean, if you look at China's weight in the [aqui 00:40:58], many of our investors look at the aqui. China's weighed is in at around 3.6, 3.8 percent of the aqui. Well, Japan has doubled that. Yet, China's market cap is that or above Japan. It's only a matter of time before passive money increases China's weight in global benchmarks, whether it's fixed income benchmarks, with the opening of the bond connect, or whether it's equity benchmarks.
David Dali: And so, my guess is, China today has fairly inexpensive valuations for what you get in earnings. And it's only a matter of time before that's normalized. And the passive money coming in from the normalization of China's benchmark weights, is really gonna go a long way. So, listen, I think that when I look in the mirror, I own not enough China. Most of our investors I talk to, if you think ten, 15 years out, I don't know how many good investible themes outside of this country, I think China's one of them.
Jim Bell: Yeah. I would agree with that. Certainly as I mentioned earlier, the valuations on Chinese stocks and stocks around the world, it's good value. It's time to get in at good prices.
Hoda Emam: Okay. So, Terry, when we think about the muni market, we don't always think about trade fears. But how does it color headline risk for investments in bonds of say California Ports?
Terry Goode: That's a great question. When we think about trade wars and tariffs, they're gonna acutely affect west coast ports the most. So, you think about Port of Long Beach, Port of Los Angeles, Port of Oakland, Port of Tacoma. A large amount of the cargo coming through, it's gonna be impacted. Port of L.A. has mentioned upwards of 25 percent being impacted. So, a lot of headline risk around is that gonna impact the credit quality of these particular bonds? I would say no. Most of these ports have long term agreements, or long term contracts, with minimum annual guarantees that really cover debt service already.
Terry Goode: And so, many ports were trying to get ahead of the tariffs as well, and so we've seen record levels of cargo this year coming through. So, I would say we would see any sort of weakness in the pricing of those particular bonds, which typically are higher rated as a buying opportunity. Another important note. Most of these ports have better balance sheets, so days cash on hand in excess of maybe 700 days or so. We'd also look at ports that benefit from having an airport. Not just being a seaport as ones that would probably weather the storm as well. So like a Port of Oakland.
Hoda Emam: Okay. I recently watched the movie Crazy Rich Asians, and I felt like, aside from it being a great movie, I enjoyed it, but it also gave me a window into a world that I really didn't know existed. And so, the rise of the middle class across Asia is a popular narrative. But is this an investible story?
David Dali: Oh, I can jump in with that. I mean, certainly we get a lot of questions about that as well. First of all, is the rise middle class real, and the wealth effect of the consumer, is the consumer a really good way to go. There's been a bunch of really good research done in emerging markets over the years, but one of the pieces of research that I really like was just published by Brookings in February of last year. And what they did, is they looked at the global middle class, and they tried to analyze where the next two billion people to enter the middle class are gonna come from.
David Dali: And what they did, what they found out was that somewhere above 80 percent of the new middle class is gonna be in Asia. And so, what's interesting about that, it's not so much where the middle class is going to be, but where they're gonna spend their money. Where is the middle class gonna spend their money? And Brookings tried to put some numbers around it. I mean, they basically came up with, over the next gonna call it ten to 12 year period by 2030, the Asian middle class will be spending 23 trillion dollars more. That's a per annum number, that's not aggregate. 23 trillion dollars more per year on PPP basis, that's a lot of extra money.
Hoda Emam: Right.
David Dali: And so, at ... I think about it all the time. I mean, how many really interesting themes are out there, outside of our country. And you can't really bet on commodities, you can't bet on currencies, they're too volatile, but the consumer is the slow, steady, investible theme. And like I said before, it really has some asset allocation benefits. I mean, it does come with lower volatility. They're typically higher growth companies. Yes, and they come with small mid-cap stocks. There's all kinds of great benefits with the consumer. So, at the end of the day, yes, it is investible. And it's a theme that's real. I know you hear a lot about it, but there's some meaningful data as to where this consumer's gonna spend their money.
Hoda Emam: Okay. And is it, when it comes to learning more, can Japan teach us anything? Can we learn any lessons from what Japan is doing in this?
David Dali: Japan was an absolute boom in its stage of growth, right? Now, Japan has declining demographics as we all know, it's got an aging population. Certain Asian economies, they're gonna go through the same thing. I think one of the things we can learn is that the power of the consumer ... Japan is really benefiting. I mean, today, as a strategist, Japan was almost uninvestible for the better part of two decades. Maybe, Jim, you can atone to it, but when Japan was zero growth and zero inflation for the better part of 20 years, you might think well how in the world can Japan Inc. really grow? How can you benefit from that?
David Dali: I mean, think about Japan today. It's got a whole class of companies that are Japanese companies that have this brand new shiny consumer in broader Asia. The fact is, that Japan prices and ... Japan makes fantastic products. They've always been fairly expensive. But with no inflation over the last ten to 15 years, a lot of those products really haven't gotten more expensive. But what has happened? Broader Asia's gotten richer. The Chinese have gone from 2000 dollars a head to making 11000 dollars a head. Well, it's the same dynamic in Malaysia, and Thailand, and Vietnam. So, what's happened is Japan has this brand new shiny customer in broader Asia. And that's what makes Japan a true growth market today in many ways. So, we have learned from Japan. Japan has certainly benefited from this rise of the middle class of broader Asia. So, yeah.
Jim Bell: I think one of the things that we can learn from Japan, too, Japan historically has been a very purist culture. They're very proud of their culture, they want to keep Japan Japanese. They're not really fond of immigrants. They've kind of been a discriminatory, anti-immigrant culture. There was just a report in the last week where the Japanese government has made a plan to bring in 300000 foreign workers. So, they're recognizing the problem, as David mentioned, their population's been shrinking. And yeah, we have a labor shortage in the United States. There's at least 700000 job openings that can't be filled, because we don't have the right workforce. The answer to that, like Japan is to have an efficient, due diligence driven immigration policy with integrity and safeguards. And we're going in just the opposite direction. So, I think that labor shortage, it's hurting our economy. If we had 700000 more people working or more than that, that would be great for our economy, and we're missing that opportunity.
Hoda Emam: All right. So, when it comes to trade wars with China, what other Asian countries, including Japan, are benefiting, or maybe not, from the trade wars?
David Dali: Oh, I'll jump in on that one as well. I was just in Asia two weeks ago, and I went to Vietnam and Thailand. Two great examples of countries that are actually benefiting from a trade war. If there is a beneficiary, and there are very few beneficiaries of trade wars by the way, in my mind. Businesses that set up shop in China are now migrating to places like Vietnam and Thailand. Partially because the cost of labor is so much lower in those countries, but also because these countries have created an environment to where it's easier to to business in many ways in some of these countries.
David Dali: So, what we're seeing is, when I go to the U.S. Department of Commerce, or the European Department of Commerce in these countries, instead of getting one or two inquiries a week about businesses wanting to move from China to Vietnam for example, they're seeing three, or four, or give inquiries a week. And then, some of those inquiries actually making their way and people setting up factories, et cetera. So, there are absolutely winners and losers, and I would say that when you think about Asia, and [Azian 00:50:37], people don't know about Azian. Well, Azian sits between India and China, right? So, these two behemoths, basically, in economic development, and there's Azian, which is this fantastic conduit of trade between these two big boys, right? And so, it's really a very interesting dynamic. But there are plenty of winners and losers from trade.
Hoda Emam: I recently also read about Taiwan, how some of the business from China is shifting to Taiwan, and seems like there could be a shift when it comes to business and how the U.S. is doing business with Asia. I mean, do you think that ... Will U.S. transnationals shift business to other Asian countries?
David Dali: Well, they certainly are already. I mean, the fact that with this IP problem you mentioned earlier, if a U.S. biotech company wants to set up in China, but they have to give their IP to their Chinese joint venture company, they might be reluctant to do that. If they could move to Vietnam and not have to give up their IP to get their manufacturing done, maybe that's a better way of doing business. So, we're certainly seeing shifts in the supply chain. Not necessarily always away from China. China still has the majority of the intellectual capital when it comes to supply chain management. But we are seeing countries like Vietnam, like Thailand, like Indonesia, becoming much more advanced when it comes to supply chains. And so, businesses can migrate much easier than when they were able to do so three, four, five years ago, and much faster.
Hoda Emam: Okay. Let's move over to Europe. How much should investors care about a potential hard Brexit?
Jim Bell: I think it's very disruptive. There's so much uncertainty around it right now. I mean, one of the scenarios is a Brexit with no deal. Which would be really chaos provoking, and that's a real possibility. Prime Minster May is in a very weakening position, she's kinda hanging on by her fingernails. The other problem with Europe is that it's kind of leaderless. Like Angela Merkel is a lame duck that German citizens have kind of turned against there with their sort of populist wave. And Emmanuel Macron is also very weak. French citizens are protesting like crazy. It's all very destructive. So, that's a worry point. Having said that, European stock markets do offer good value. And as Terry mentioned, the Italian crisis is not insignificant. But as many investors like Warren Buffet say, the time to buy is when nobody else is buying.
Hoda Emam: Could uncertainty in Europe sort of feed into a global slowdown?
Jim Bell: You've got three big boys, so to speak. You've got the United States, you've got Asia, and you've got Europe. So, those are the three dominant capital markets, so if one is suffering, it's gonna hurt everyone else. It's gonna hurt the other two, so yes. I think that kind of influence of capital markets among these big economic and trading centers is important.
Hoda Emam: Terry?
Terry Goode: Yeah. It's one of, I guess, the big reasons why we're constructive on the municipal bond market, is because when we look globally and we look at slowing growth, and we look at an increasingly hard Brexit possibly happening, and like we talk about Italy having high debt load, I think it makes us constructive on the U.S. market, and it's something that we're watching very closely.
Hoda Emam: All right. Did you want to add anything, David?
David Dali: Nope.
Hoda Emam: Okay. Let's bring it back to the U.S. Will U.S.'s economic growth continue on pace in 2019?
Jim Bell: It's not gonna be on pace like it has been this year, with I guess our high point was 4.2 percent in the second quarter, I believe. I think for the first time in 13 or 14 years, it's likely that we'll end the year at a three percent growth rate GDP. Which is a 50 percent acceleration from what we were experiencing around the two, 2.1 range. So, that's healthy, it creates a certain momentum. And as we've said, the 4.2, that wasn't a sustainable rate. Three percent might be sustainable, but even if we drop to 2.5 or 2.75, growth is still growth. So, if we can tamp down these other concerns, Brexit, China, the Fed, then I think the prospects, the momentum with so many people being employed and interest rates low and inflation tame and strong consumers, I think 2019 could be a very decent year for investors.
Hoda Emam: Okay. Did you want to add anything, Terry?
Terry Goode: I would agree with that. I think, we think U.S. growth is gonna be find. Definitely not calling for a recession or anything. So, our base case is that we may see some slowing because of the external events that we've been talking about today, but we do still think the U.S. is on pretty solid financial footing at this point.
Hoda Emam: Okay.
Jim Bell: I would just add, too, that I've been critical of President Trump, but certainly the tax cuts and the deregulation that he's been able to do have been wonderful. It's be great for business. It's been great for investors. I just wish he'd a left it there and not started getting so obsessed about tariffs.
Hoda Emam: Okay. I'm gonna come right back to to that in just a minute.
Jim Bell: Okay.
Hoda Emam: What are your predictions for the U.S. worker and consumer in 2019?
David Dali: I'll leave it to the U.S. Experts.
Jim Bell: [crosstalk 00:57:05] Yeah. Yeah. Okay. So, we do have ... We're seeing wage growth. It's coming on slowly, about 3.1 percent's a big improvement. Many people are being pulled out, pulled in to the labor force, who had opted out.
Hoda Emam: Opted out as in retiring?
Jim Bell: Or just choosing not to work. I mean, maybe they could afford to do that, or they were just so discouraged. But now people are being more encouraged. Employers are doing a lot of searches for people to fill their workforce slots. So, I think with inflation being tame, and that the growth momentum, settling down a bit, but continuing at maybe two-and-a-half percent plus in terms of GDP, it's gonna be good for the American worker and the American consumer, and the American economy.
Hoda Emam: Okay. Well, on to politics. I said we were gonna come back to it. What's worrying investors about current incoming Washington fights?
Jim Bell: I think Michael Lewis' latest book called The Fifth Risk, is where he analyzed the Trump approach to taking over the federal government and all the agencies. And it's a very serious book, a very critical book, that the leaders and managers of all these agencies just didn't give a damn. The Obama Administration had done tons of work to put together briefing folders, notebooks, whole seminars, and nobody showed up.
Jim Bell: So, I think the stress on the Trump Administration with the scandals, the criminal activity, the Mueller probe, Trump is under so many different investigations from his charitable foundation, to his businesses, to the Russian connection, if there's something material there, that's still to be determined. It dampens spirits. And so, we've depended on confidence in consumer confidence, and that kind of a chaos and shoot-from-the-hip dysfunction is really bothersome to people. And the Twitter feed is totally out of control.
Hoda Emam: David?
David Dali: We would jump on the bandwagon a little bit. I mean, from our perspective as international investors, we want stability in policy, right? We want stability. We want independence of the Fed. We want some continuity of trade. Something that businesses can count on year, after year, after year. I mean, certainly corporate earnings are dependent upon some level of stability, and unfortunately with the Trump Administration, we're lacking some of that stability. And that's certainly what's feeding into credit spreads to a certain degree. Equity [inaudible 01:00:15] to a certain degree. So, we would echo some of your comments certainly. From our perspective, we would just like some more stability, we'd like more predictability from the administration, and that would help quite a bit.
Hoda Emam: Okay. And one last question on this front before we wrap up. Jim, some of your clients view President Trump as acrimonious, how does that affect their investing outlook?
Jim Bell: Well, as you'll recall, when the Trump election became realized, that yeah, he really is gonna be president, the futures market tanked in the middle of the night that Tuesday morning ... Or, I guess Wednesday morning, actually. But in just a matter of a few half hour increments, people started to think, "Well, he's really talked about cutting corporate tax cuts, and deregulation, that's gonna be good for business," so the market resolved itself really fast in terms of it being positive for business and investors.
Jim Bell: But as I mentioned, his activity on Twitter, it's discouraging, it's not encouraging, it's embarrassing. So, like I said, there's ... I think there's kind of a cloud hanging over the country about him just not being professional. His acting chief of staff called him a terrible human being just two years ago, Mick Mulvaney. So, there's a lot of people see that, and on the Republican side they're willing to overlook it for policy reasons, but it's not helpful, let's put it that way.
Hoda Emam: All right. And last question. As far as your takeaway for 2019, what should our audience most closely keep in mind for planning investment portfolios in 2019?
David Dali: Well, listen. From my perspective, I'm quite confident ... To me that some of the big headwinds that were in place early in the year with tightening of monetary policy, higher oil prices, trade conflicts, stronger dollar, all of those headwinds in my mind are set to dissipate. So, the moral to the story is we think risks today are actually much lower than they were this time last year. And we should think about it that way in thinking about 2019.
Hoda Emam: Okay.
Jim Bell: And out priority at Bell Investment Advisors is financial planning. So, our mantra is that any investment strategy portfolio construction should be guided by a comprehensive financial plan. Otherwise, we think people are just kinda shooting in the dark. And what really matters is the personal benchmark of everybody's goals and where they need to be and where they need to get over time. So, long term thinking is really important as far as we're concerned. We're not traders, there's a big difference between trading and investing. The media loves to emphasize trading, because it's more exciting. Long term investment strategies are kind of set and can be boring. But we think having those personal benchmarks for yourself is the best way to measure where your life is headed, and whether that gives you piece of mind or you need to change strategies, that's what's really important. Not what the indexes are doing or what your neighbor bought Apple at or something like that. So, financial planning is really a major emphasis for us.
Hoda Emam: Okay. And Terry?
Terry Goode: And for us, we're constructive on the municipal bond market. We think 2019's gonna be a positive year. We think extending duration is prudent. We think our yield curve is steep. There's opportunities out the curve. We also think focusing in on higher credit quality purchases, not necessarily selling your lower credit quality, but being careful that you're being compensated for any lower credit quality that you're taking. So, really constructive on the muni bond market.
Hoda Emam: All right. David, Jim, Terry, thank you so much for taking the time to share your insight with us. And thank you to the viewers for tuning in. Make sure to take the corresponding quiz for your continuing education credits. From San Francisco, I'm Hoda Emam, for Asset TV.