MASTERCLASS: Gold - September 2020
September 3, 2020
Jenna Dagenhart: Welcome to Asset TV. This is your market volatility and economic uncertainty masterclass. In addition to the human toll, the coronavirus pandemic has had a devastating impact on the economy, sending us into a bear market at record speed and potentially a recession. Today, we'll cover what a recovery might look like, investment opportunities and challenges, monetary and fiscal stimulus measures, and more. Joining us are three expert panelists, Chris Dillon, multi-asset class strategist at T. Rowe Price, Dirk Hofschire, Senior Vice President, Asset Allocation Research at Fidelity Investments; Tam McVie, multi-asset strategist at Aberdeen Standard Investments. Gentlemen, thank you for joining us.
Chris Dillon: Thank you for having T. Rowe Price.
Jenna Dagenhart: Absolutely. First things first, I want to talk about the US economy because we're in a very unique state right now, historic times. Dirk, how would you summarize the kind of colossal market moves that we've been seeing in this new normal?
Dirk Hofschire: Yeah, you're absolutely right. It's really unique, it's really unprecedented, frankly, in our lifetimes, probably well before that, to have any sort of sudden stop like we're having in the economy right now. We had sort of felt for a while, and really all the way back to sort of October 2018, that the US economy was in this late-cycle phase. But it was kind of a prolonged, relatively steady one, even though the markets have been volatile in it. There hadn't been a huge catalyst to push us into recession, and then all of a sudden, of course, the virus, a huge exogenous shock.
Dirk Hofschire: Again, I think it's difficult to figure out exactly how long this is going to last. But, obviously, we start with we're probably in recession already today, and that's causing, obviously, a lot of the trauma that you just mentioned in the financial market. But I think it's also there's open-ended uncertainty with the virus itself. We have the virus and then the reaction to the virus, which is essentially to clamp down on economic activity almost overnight. None of us know exactly how long the clamp down is going to last because none of us know exactly the pattern of the virus. I think in that huge, huge black hole of uncertainty, that's when you get big, wild fluctuations in the market because things can look really, really terrible one day and then maybe not so bad the next.
Jenna Dagenhart: Yeah. Dirk, you bring up a good point, as uncertain as the markets are right now, the virus itself is even more uncertain. Chris, turning to you. How would you describe our current economic state in the US?
Chris Dillon: As described, it's a sudden stop. I think I'll take a look back to late 2015, early 2016, which was an oil shock. Oil prices, WTI oil prices dropping below $30 a barrel. It felt really bad in late 2015, early 2016. That was just the oil shock. I think, relative to that environment, think about how that played out in late 2015, early 2016, where it wasn't a recession by definition but, technically, it could potentially be described as one. But let's not forget, first week of February 2016, WTI oil prices were around $25 a barrel. United States, exerting soft power, was able to work with OPEC, get supply controlled.
Chris Dillon: By June of 2016, oil prices were back up and over $50. We all went back about our business. That shock went ahead and disappeared. That was just an oil shock. We've had an oil shock, and now we've had COVID-19 which, from our perspective, at least 80% of the sudden stop is COVID-19, on top of what was already considered pretty bad and had pretty negative impact in 2015-2016. You think about that, and you think about the first unemployment claims that come in relative to a sudden stop, we were thinking to think more than a million unemployment claims at T. Rowe Price.
Chris Dillon: When that number comes in at three times, that estimate gives you the perspective on what happens to the real economy when you take, again, what happened in oil markets, which was quite uncomfortable back in late 2015, early 2016. Just go ahead and throw another seismic shock on top of that, and here's your first inkling of what that means to the US economy. Completely agree, US economy is in recession. It'll look probably mild here for Q2, potentially flat, modestly negative for Q1 rather.
Chris Dillon: But for Q2, I mean, I'm looking at the estimates as they're coming in from across the street, you're seeing anywhere from minus 10%, minus 20%. Pretty bad. I think the silver lining here is you're seeing some success with regard to where did COVID-19 originate? In China. Is it getting better there in terms of what they're reporting? Absolutely. Is there incidence of success in South Korea? Yes. Singapore? Yes.
Chris Dillon: You see a playbook emerging where there is another side to this. I think based on those signs of success; we see a light at the end of the tunnel forming in Q3. But, yeah, couldn't agree more, US economy in recession, but we're hopefully thinking somewhat deep but somewhat shallow in terms of duration as well.
Jenna Dagenhart: I'm glad that you bring up the jobless claims because they hit a record 3.3 million in just a week, and some people are saying that this is just the beginning. Tim, I mean, looking at this, what kind of economic indicators are you watching?
Tam McVie: I mean, I think that the jobless claim is, obviously, a key one to be looking at because of the sudden nature of this halt to the economy essentially. I think that's one that we're really following very closely. Other signs that we need to be looking at, in particular things around corporate defaults, for example. Again, this may be a little bit too early right straight away, but that's the next sort of sign to see whether this goes from maybe that that kind of recession that Chris just described in terms of recovery later on in the year, the kind of waymarks that we're looking for, or does this actually turn into a full-blown financial crisis?
Tam McVie: Because, again, I think one of the key issues with this is that we're going through a health crisis, not a necessarily financial crisis, all the action, all the fiscal policy that we've seen, the monetary policy that we're seeing is trying to provide a backstop from this sliding into a financial crisis. While we need to look at jobless claims, et cetera from an economic perspective, we need to start looking and be very thoughtful about whether this actually moves more like into a financial crisis. That would have a profound effect on whether or not we get that rebound or not in the second half of this year.
Tam McVie: Yeah. I think that the key here is looking at understanding where jobless claims are, where earnings are going from a corporate perspective, but then really being very vigilant in terms of the financial stress and whether we're actually seeing pickups of that. We've already seen pickups and financial stress. But whether we see a continuation of that and whether that leads to a more prolonged default cycle, more prolonged cycle of shedding labor and/or households, essentially, increasing their savings rates, et cetera. All those sorts of factors are key. I don't think there's much argument about where we are today. We're in recession. But the question mark really is about how and when do we get out of that? What is the recovery claim?
Jenna Dagenhart: We'll talk more at greater length about what that recovery might look like. But before we get there, Chris, what does your short-term outlook look like?
Chris Dillon: Our short-term outlook, and it's not directly answering your question, but I think something we haven't talked about yet is capital markets themselves weren't working. I think behind the scenes, if you think about the Federal Reserve, not only did they cut effective Fed funds rate down to zero, they have also pulled out a enormous bazooka in terms of stepping into the markets, unlimited quantitative easing, purchasing first commercial paper, expanding that out to buying mortgage-backed securities, expanding that out to interest rate swap lines following the playbook that came with the global financial crisis of 2008.
Chris Dillon: When you see a global shock, there is a sharp rising demand for the US dollar. If you were to look at $1 index like the DXY, several weeks ago, that index would have been about 95 at the height of fear as we are migrating through the week of March 23rd, and just before the dollar index got out to 103. I think as those Fed programs have stepped in, kicked into markets, do you see that sharp demand for dollars, which is a sign of stress for the economy? Does that dollar index come down from 103 to now less than 100? That's happening. That happened during the week of March 23rd, so check that box.
Chris Dillon: But commercial paper markets were frozen that first stepped in to buy commercial paper, putting some liquidity into the system, a dash for cash. Just a couple of weeks ago, my last trip on the road before the crisis reached this extra level of terribleness, if you will, not the best word. But, anyway, Boeing pulling down its entire $14 billion credit line three weeks ago, and was in a client meeting, and we both looked at each other and said, "They won't be the last." Certainly, they weren't the last, and that dash for cash has happened.
Chris Dillon: Then you think about central banks, if they're going to step in and buy securities, they can't do that with 10-year treasuries that they're holding. They have to convert that into a type of T-bill to go ahead and step into markets the way that the Fed is doing, the way that the ECB is doing. That forces the selling of 10-year treasuries, 30-year treasuries all about the dash for cash. This put enormous strain on short-term funding markets, entire T-bill curve goes negative. Fed had to step into that, stabilize money markets. As that's happening, you're seeing pressure easing from that perspective, allowing markets to return to some type of function. It's good to see some blue chips, like McDonald's, actually able to issue corporate debt. Good sign in terms of markets returning to function, but I think we've been looking at that.
Chris Dillon: As we look at the market returning to function, from a near-term perspective, it's assessing, all right, when is the market returning to some type of normal that when then we can assess valuation? Assess valuation, thinking of the opportunities 6, 12, 18 months from now, what does the post-crisis period here right now look beyond that timeframe? But we can't. We're doing that work. But it's hard to do that work when markets themselves aren't even working once that stabilization happens. I think it's, for us, a little bit of wait and see here, waiting to execute because there are enormous opportunities in the market right now.
Jenna Dagenhart: Dirk, I know you have a lot of thoughts on the dash for cash. How has all this market volatility impacted liquidity?
Dirk Hofschire: Yeah. I think Chris raised a lot of good points around the liquidity shortage. I think it wasn't even just a liquidity crunch. It was sort of a liquidity seizure. I mean, a lot of our traders, portfolio managers, especially on the fixed income side, felt that a lot of these days look worse than 2008 in terms of liquidity. Nothing was selling. It was just impossible to get bids. I think the highlighting of some key vulnerabilities that we went into this with makes me a little cautious here in the short-term to say that the worst is necessarily over. I think you highlighted, Chris, the dollar, the dependence on dollar, borrowing around the world. That was a vulnerability going into this. As that money started to flow out, then there's just not enough dollars, and so part of this is going to be the Fed flooding the world with money.
Dirk Hofschire: Part of the other vulnerabilities, though, is just a lot of debt, a tremendous buildup of debt around the world, generally, right here in the United States, huge corporate leveraging has gone on the past several years. For a while, it was obviously a very virtuous cycle. Low volatility, low rates through monetary policy, lots of liquidity and global investment. You have driving spreads tighter and tighter. It was great for investors. The problem is when you have a stock of debt that is that large, you really depend on those rates staying very low.
Dirk Hofschire: What happens in these acute liquidity stress situations is people start to worry that it's not just liquidity, it's solvency. I think we're hopefully nearing the end of the first phase, which was this acute liquidity seizure in the markets. I think the Fed, as Chris said, is doing a ton of unprecedented, even relative to 2008 2009, unprecedented the size and scope of these programs. But that's still only liquidity.
Dirk Hofschire: The underlying issue is still going to be one of what are earnings going to look like on the other side? How many of these companies are going to go in default? How many other forced leveraging and aftershocks of all these other leveraged trades and things that haven't happened yet? Almost always, when you get moves of this type, it's not just one or two weeks of hits, it's then a process of sort of rolling for selling, deleveraging and whatnot.
Dirk Hofschire: I think in the short-term, because this is falling on some existing vulnerabilities in kind of the global pipes, which includes the right post-GFC regulation here in the US, we just aren't going to get the liquidity back and we're going to have questions around what the world is going to look like on the other side. Because at the end of the day, the Federal Reserve can help lower the borrowing costs and create liquidity for the markets. But it's not actually more borrowing that is needed. Layering more leverage on the Corporate America isn't necessarily what you're going to want to see a year or two from now in the recovery. That's the part, I think, until we get more visibility to that, the short-term is likely to still be pretty volatile.
Chris Dillon: Those are great points. Couldn't agree more with everything said. I think where we'd agree, and I'd say it a little differently from T. Rowe Price's perspective, is liquidity getting addressed but we are going to have a credit cycle. There are going to be fallen angels. You addressed leverage, investment grade credit. Pre-crisis was about a $5 trillion space, 30% BBB. Today, a $10 trillion space, greater than 50% BBB. In a sudden stop, this places pressure on rating agencies that came under a lot of pressure for not acting quick enough global financial crisis. I'm sure they haven't forgotten. 200, 300 billion of the fallen angel debt working its way through high-yield market, we are going to have a credit cycle. I couldn't agree with those points more that were just said.
Dirk Hofschire: I think the next phase, hopefully, and you alluded to the opportunities, is now we get to a little more price discovery, because for a while there in that liquidity, crisis, seizure, whatever you want to call it, all the correlations go to one and everything sort of goes down at the same time. I think you're right, there are opportunities. The first step of this is kind of more on the micro, more of a multi-asset class, macro top-down.
Dirk Hofschire: But when I talk to our other portfolio managers on the equity side, the fixed income side, this is an exciting time to be in security selection. As we move through that sort of phase now, I think, of better price discovery, you're able to separate the wheat from the chaff. I think from the macro standpoint, it's still going to be a lot of bouncing around, a lot of volatility.
Jenna Dagenhart: Tam, how has your market outlook changed given all this volatility, all these liquidity concerns?
Tam McVie: I'm just going to pipe in there really on the basis that a lot of what we talked about, I mean, I'm in agreement with it. It's very market-related. The reality is, certainly from our perspective, is this is just very different and it's already been mentioned, but we need to be thoughtful about actually the types of waymarks that we're looking for rather than being market-related have much more to do with actually the containment of the virus, whether that's successful or not.
Tam McVie: Because until that happens, price discovery et cetera and looking for liquidity and looking for opportunities is quite limited in terms of your short-term outlook is, quite frankly, just completely and utterly opaque. There's no way of making a discernible decision based on a market decision with having a very strong view on how this virus is going to be contained.
Tam McVie: I think on the Silver lining perspective from that angle, we can see somewhat a roadmap in China, for example, after 8 to 10 weeks of very severe lockdowns. They're kind of opening their economy back up. We've seen some positive signs from containment in terms of tracking and keeping smaller populations isolated in Korea. Even in Italy, actually, we're seeing that containment come under some successes in terms of just the new number of cases on a daily basis coming down. There are positive signs coming from there. But the question mark is, A, then how does this all further affect the US and how does the containment work? The argument in the US that we're starting to see is, is containment the right thing to do or does that, in effect, cause more problems by a full-blown and long-lasting recession?
Tam McVie: there's also other areas in terms of we've not really seen this virus take place to the same extent in less developed markets, particularly say Africa, for example. I think any decisions about outlook and potentially taking advantage of some of the massive discussion that's been created in markets, the types of waymarks that we're sitting, waiting for it. Not necessarily market-related, they're actually much more to do with some form of signals of containment, and then you need to be doing the work on where you think you can take opportunities. But the top-line piece that you need to consider in the first instances, are these containment measures actually effective?
Jenna Dagenhart: I see you nodding your head, Chris. Anything you'd like to add?
Chris Dillon: No, I think the point about breadth of the crisis and it's all about the human element here and to the extent it is a fight against a pandemic. The breadth of this, I mean, if you're thinking about where there's a compare and contrast between the United States and China, China, a command economy able to completely shut their system down from the top-down. It's interesting to compare and contrast that with the experience here in the US where you don't have that heavy hand coming in from the federal government. It's more about governors responding in so-called "hotspots."
Chris Dillon: New York, California, New Jersey, but happening at the state level, not the federal level. I think that makes the calculus here in terms of the human element more complex than China. But those data points good, gives us more optimism in terms of there is a success to combating this, but a little bit different experience here in the US, which makes the calculus complex. But it is absolutely right, it's all about combating a pandemic here.
Jenna Dagenhart: The President has said that he hopes everything can return to normal by Easter time, although that's a much shorter window in terms of our lockdowns in the US compared to China. Do you think that that's realistic, or do you think that markets rather are optimistic that things will return to normal by that time when really it might take longer?
Chris Dillon: I think our perspective is Governor of New York acting appropriately. I live in the great state of Maryland. Our governor, acting in conjunction with what's happening with the rate of incidents of COVID-19 in the state of Maryland, he'll act accordingly. I'd say the governor here in Maryland, and just looking at him on local TV, he's not taking orders from Washington, DC. He's going to act as a governor overseeing Maryland. That's happening in New York, happening in California.
Chris Dillon: The idea that we're just going to put the switch back on at April 12th in terms of the entire country, we don't have that expectation and I don't think the markets think that either. I think that the market's reaction during the week of March 23rd as federal programs came in, that was the idea that United States isn't going out of business. The Federal Reserve has stepped up, and the United States Congress got past stark divides from a partisan perspective and delivered a generous fiscal side. That's the initial relief. But the fundamental side of this is next, which has everything to do with breadth. No, I'd say our expectation is April 12th is not a magical day by any stretch.
Jenna Dagenhart: Governments around the world are following the lead of central banks and reacting with fiscal stimulus. Tam, what kind of impact are they having on the economy?
Tam McVie: I think, I mean, this is all coming down to, again, fiscal and monetary policy looking to act as a backstop, essentially, to try and stop this from escalating into a full-blown financial crisis. I think that's the best that really the fiscal policy can look to achieve. Again, the key kind of aspects that we've got to be thoughtful about is around how containment around the virus works. Then from there, how well does the economy or how well can the economy recover. I mean, essentially, the size of some of the policy decisions have been very sizeable, obviously, in terms of there's been a reasonable amount of inventiveness around them.
Tam McVie: I think that the fact that the global financial crisis was relatively recent is still definitely playing in policymakers' minds. It would be much faster to move this time around than they were in the global financial crisis, for example. Those are some of the reasons why we think that our baseline case is still that we would get some form of a U-shaped recovery.
Tam McVie: One of the reasons being that policymakers have acted incredibly quickly. But as to whether it's successful for markets or for actually turning around markets, probably less convinced about that in terms of, on the day, clearly, we've seen a positive reaction in equity markets from the announcements around certainly the US policy announcements. But, again, is it enough to entirely shift the course of markets? That's debatable, and we'll need to see that.
Jenna Dagenhart: Dirk, when lawmakers promised that they were close to a deal on fiscal stimulus, the Dow surged 11% in a single day, the best day since the 1930s. What do you make of some of these major market moves that we've been seeing in response to fiscal and monetary policy?
Dirk Hofschire: Well, I think, again, we've had huge volatility on the downside and the upside, and it goes back to the tremendous amount of uncertainty that we have on the outlook over the next 6 or 12 months for the virus, for the economy, for the corporate side. I think there is good news from the policy standpoint as we've discussed that as much as we talked about the Federal Reserve speed and scope being sort of amazing, to me, I'm actually even more impressed that Congress and Washington, DC moved as quickly as they did. It looks like we are going to get a package upwards of $2 trillion. That's nearly 10% of GDP. They're going to have done it in less than two weeks.
Dirk Hofschire: That's, frankly, amazing from a political sort of timeline. Now, the analogy, I think, here is more that you have to realize as long as this shutdown goes on and the virus-related tamp down on activity continues, you're still digging the hole. All of the stimulus can kind of fill some dirt in, so the hole doesn't get so deep, but it's never going to replace what you're digging. I think it is going to help stabilize. Probably, more than anything else, what it helps do is kind of remove that far left tail of sort of the spiraling into a great depression. That's good. Absolutely no question.
Dirk Hofschire: On a human level, it's obviously going to provide a lot, both in the healthcare space, as well as people that have lost their jobs, et cetera. But it is actually a very sizable package. It goes back, we still don't know the trajectory of the virus and how long things are going to be shut down. But if it does end up to be on the shorter end of kind of consensus expectations, whenever that might be, I don't know, two, three months, something like that, there's so much fiscal stimulus. Not all of that is going to get into the pipeline in the next two or three months. But it may actually help boost somewhat into the recovery.
Dirk Hofschire: But if we're close in, at least a majority of workers and activity is closed in four or five months from now, especially if you're still not sure when we're going to get back to full, this is just going to need to be the first of many more stimulus, because even as big as it is, as we talked about in the beginning, the output shock has been even faster and even deeper.
Tam McVie: Just to add to that, I was just going to say that the point around the length of time that we're talking about, there's been quite a bit of work done. I mean, it's modeling. Just take any kind of modeling with a pinch of salt. But, ultimately, there's modeling that would suggest that we might be in shutdown for two-thirds of the time over till the end of 2021.
Tam McVie: That, I don't think, is in anybody's base case at the moment. If that were to occur, then clearly, we're going to see markets react considerably worse even from this point, and we'll need to see more action from a fiscal perspective and from a monetary perspective as well. Albeit, it's kind of difficult to start to see what more can we do from a monetary perspective. But the other point around that is also around and, again, one of the kind of key waymarks to be looking for in terms of is this the kind of U-shaped recovery or is this actually a much more prolonged recessionary depression type scenario is actually if we start to see the occurrence of COVID-19 in places like China, for example.
Tam McVie: That's kind of one of these things where I think there's the assumption that it will come under control even in a couple of months is being questioned by large number of people, a large number of academics, and the assumption that you're going to get a vaccine and that you're going to be able to produce seven billion prescriptions for it, et cetera. All of these things, we're assuming that these things are happening. But they're just assumptions this time.
Chris Dillon: I got a couple of perspectives from a different angle. It is a time for creative thinking and extraordinary conditions. Interesting thinking by investment professionals at my firm, just talking about the Spanish influenza pandemic of 1918, and how long it took the world to get back to normal out of the Spanish influenza pandemic of 1918. It wasn't until 1922 that the world actually returned to normal, and the Roaring Twenties didn't start in 1920. They started in 1922, just to put some sobering perspective on some of those points that were just made.
Chris Dillon: But to the extent that it's somewhat shallow, and we remain optimistic that green shoots appear as we get and migrate through Q3, you start thinking about if the S&P 500 is hovering in the range of 2,500, but this persists, what happens to earnings to actually put a framework on what a floor could look like here if we get back to some type of normal? S&P 500 earnings last year are about 168. To the extent that you have stress test different scenarios where there have been air pockets for earnings in the S&P 500 in historical recessions. You can certainly make a quick argument that earnings move from 168 down to 130. You think of a multiple that was 20 times on the S&P 500.
Chris Dillon: How about we forget that? Why don't we apply 15 times multiple? The quick math on that allows you to quickly get to a floor on the S&P 500 of 1,950 points. That is not a promise by any stretch of the imagination. But if we're hovering mid-2000s on the S&P 500 and points made here, which are absolutely valid of persistence of the experience that we're in, it's not a time to stop thinking that work that we've reached the floor already. It's also a good healthy exercise to think of what a floor could be relative to when the world returns to normal. What does that normal look like just in some additional perspective?
Jenna Dagenhart: Yeah, and you raised a good point, too, about the human toll with this comparing it to the Spanish flu. A large part of economic output GDP potential is your manpower, your labor force. Then if this were to kill a lot of people, that could be devastating not only for us as a country, but also for the economy and demographics.
Chris Dillon: I think the messages that our chief investment officers across our global equity complex have been conveying to our investment team is don't get caught in the trap of thinking about where prices were before this crisis erupted. If you think about a stock like United Airlines hovering 115, 120 pre-crisis, drops all the way down to $50 a share, data comes in worse, they decide to stop giving guidance, and then, well, wait, they may need some help from the United States government and that stock gets into the 20s, don't think about United Airlines of going back to 115 to 120. Get that out of your imagination.
Chris Dillon: But think about United Airlines and the United States government taking an equity stake, thinking about United Airlines in terms of being integral to the function of the US. Does the risk reward of United Airlines in the 30s look attractive through that lens? I think those are just an example. It's not a promise of what happens with United Airlines, but it's just an example of where we were, how quickly we dropped down. Now, it's again thinking about after we get to some type of functioning of markets, after we get to some stabilization of COVID-19, how do we think about equity valuations?
Jenna Dagenhart: Looking at monetary policy, too, I mean, governments are kind of following the lead of central bankers who stepped in first. Looking at monetary policy, the Fed has taken aggressive measures to try to combat the pandemic's impact on the economy, slashing rates. Dirk, do you think that these measures are fully baked into markets?
Dirk Hofschire: Yeah. I mean, I think the markets recognize that this is a tremendous, tremendous response on the part of the Federal Reserve. I think it's above expectations, frankly, in terms of how quickly they moved into never-ending QE. They've created a new facility every couple days to address all the different markets. Chris touched on that before. Essentially, this new package, if it gets through Congress, is going to provide sort of seed capital or at least ability to finance risk for them to lend even more to these facilities, and really to help sort of any entity, not even just corporations, but municipalities that will see the way the programs actually work.
Dirk Hofschire: But the scope of this is now measuring even by conservative estimates far, far potentially above the response that we saw in 2008 when the global financial crisis was centered right here in the United States. It is stunning. I think the markets do recognize it. I would say, though, that I think the markets and the economy have also started to recognize over the last year or two that there are limits to monetary policy in terms of how effective they can be, one, in helping the real economy, but, two, in even perpetually just boosting asset prices.
Dirk Hofschire: I think for much of the last 10-plus years since the global financial crisis, had you just sort of stuck with the playbook or follow what the Federal Reserve was doing with the global liquidity situation, whether taking rates up or down, QE, that was probably just about as important as anything else. I think, now a decade later starting from rates much, much lower, a balance sheet that is much, much larger, certainly a recognition on the part of the Federal Reserve that it doesn't know how to really control these markets, either from a liquidity perspective or where the locate rates or the size of the balance sheet perspective. It means we're a little bit in Never Never Land right now, and I think that's a little less comforting of a thought.
Dirk Hofschire: Good news that the Federal Reserve has backstopped the liquidity, acute liquidity crisis that we've had the last several days. Sort of bad news that we had to do this, and that they had to throw everything at the kitchen sink in such short order with a catalyst like this because it means we're going to have a hard time getting out of this. The Federal Reserve is now sort of in the middle of these markets, not just regulating the markets, not just setting interest rates, but is now a very, very active lender and active dealer in almost every form of credit and every part of the financial market, and that's not necessarily where you would want them.
Dirk Hofschire: Welcome from the standpoint. Again, I think it takes a lot of that left-hand tail risk of complete collapse, Great Depression style, run of bankruptcies across the board. But what it's not going to do necessarily is put us on that kind of sustainable path back to where we were, either economically or from the standpoint of understanding exactly where, fundamentally, monetary policy is ending and sort of a free market oriented system is beginning.
Chris Dillon: Just very quickly on those points. Couldn't agree more. But you mentioned global financial crisis. You mentioned the response of central bankers, in particular the Fed, but largely a help for Wall Street and not necessarily a help for Main Street. If you could make the argument conversations happening at T. Rowe Price back half of 2019, we're acknowledging populism as a global political phenomenon not to go away. I think the argument can be made that the seeds of populism were sown out of the global financial crisis.
Chris Dillon: I think what's interesting today in terms of the response, Fed doing what it has to do, but we've already talked about it. Washington, DC helping Main Street, and potentially depending on the breadth of this crisis, I think Tam made this point. Yeah, this two trillion may not be the last two trillion. I think the recognition of how important Main Street is, is where this crisis is unique relative to the global financial crisis.
Dirk Hofschire: I was just going to mention, this is a theme that we've been thinking about for years in terms of sort of a regime shift that governments, central bankers, when you talk about deglobalization, all of that has sort of been eroding the last several years. What it means is much more active government, policymakers, regulators, less independent central banks, less rules-based orientation on global commerce and global capital flows. All of those were trends, I think, that had already started several years ago, as you mentioned. We were seeing that regime shift to kind of a higher political risk, higher policy risk, intervention risk sort of regime. I think this now just steps on the accelerator.
Dirk Hofschire: It's hard now to, frankly, find a market or a part of the economy that isn't going to feel some impact of a much heavier hand in terms of intervention, government support, et cetera. Again, once you have that happen, it's much harder to extract and get back to what we might have thought about as normal 5 or 10 years ago. The big challenge for anyone, for us certainly as investors, the bottom-line is it's probably not going to be great for profit. It may be fine for asset markets at a high level, from the standpoint that policies support should be good.
Dirk Hofschire: But the more assistance that the governments have to provide, and we're seeing it in part in this new fiscal package that's coming out, the more conditions that are going to be attached to that and the more you're going to have policymaking starting a lot more in Washington, DC, either with the Federal Reserve or with Congress and the White House. That's going to be a different environment than we've been used to the past 30 or 40 years.
Tam McVie: Yeah. I was just going to add to that. I mean, essentially, when we see this, the shift in the political regime, we're stepping back into an environment where you get in long-term fiscal policy interventions. One of the things that we've seen, in particular if you're talking about a 10-year timeframe, these regime shifts have been going on over the past 10 years or so. But what we've not seen is the accompanied market volatility pickup.
Tam McVie: We've seen over a 10-year timeframe, actually, market volatility has been incredibly subdued and has actually managed to get past any of the pickup and kind of the shift in the political regime. It's managed to get through even the pockets of issues that we saw in 2015-2016. It's gotten through all of these different types of scenarios where people's perception around risk has been quite high, but actually market volatility has been low.
Tam McVie: This may well shift us back into a more volatile regime, particularly actually when you bring it down as an investor is where your sources of diversification. If you're saying this is going to have an impact on earnings, this is going to have an impact on future growth, and even in the base case, we've probably said that that's the case, but the downside risk is probably, at this point, is still incredibly large as a kind of overall percentage.
Tam McVie: Then the thing for an investor is then, "Well, okay, well, where am I going to get diversification from?" That's much more difficult because of the starting point, and from the Fed's perspective, their starting point was rates were so much lower in any event, so they just had far less room to play with. We've seen the strength of the US dollar also is impacted. Some people will go to safe havens within the currency market. But, again, the dollar has been incredibly strong there. That's kind of impacted certain instances there. Then, ultimately, this is going to become more and more important if we're in this environment where we do actually see a market volatility regime shift also.
Jenna Dagenhart: It sounds like we all agreed that we're in the midst of a recession here, the beginning of one. I wonder, Dirk, how does the recession phase impact and affect asset performance? Obviously, it's not good.
Dirk Hofschire: No, it's not good. You nailed that one. Yeah. I think, historically, going into recession, and the recession period are the worst time for the equity markets where you get the majority of the draw downs and the biggest of the draw downs. It's pretty simple. As the economics deteriorate, the economically sensitive asset classes, like equities, like high yield, they see the corporate backdrop suffer, profits plummet, et cetera. Then you see the rotation in the more defensive assets like bonds.
Dirk Hofschire: That was a pretty predictable pattern there for two, three weeks. As markets sold off, bonds actually did well. Treasury yields fell considerably to all-time lows. Then we got into that liquidity crisis that we talked about before, and all the correlation sort of went to one, and then everything started to go down. Even treasury yields have picked up some during the volatility. I think if we are past the worst phase of that sort of liquidation, then hopefully, the correlations are going to shake out here, and there are going to be places to get more diversification going forward.
Dirk Hofschire: I don't know that for sure. But it does feel at least like some of these Fed programs are starting to provide better liquidity, and the tones been better in recent days. It doesn't mean it's the end of the volatility, and it doesn't mean it's the bottom of the bear market in equities either. It could be. No one's going to know until hindsight. But I do think that you start in this environment from an asset allocation standpoint, saying, "We just recently entered recession. We are still in the ramp up mode of that recession getting worse. We are still in the phase of the virus in this particular episode, which makes it different, where the virus trajectory is getting worse."
Dirk Hofschire: That is not necessarily the all-clear signal to get back into equities to do risk and really start buying. Now, again, for a long-term investor, a year from now, five years from now, none of this may matter, and the markets could be considerably higher. But if you're thinking about kind of the playbook for why you're in recession, it's great for a long-term investor because things just got cheaper, and actually, recession is a pretty good entry point. But in the near term, you really don't know, could things fall 10%, 20%, 30% more? Could we see a sharp 20% or 30% rally up?
Dirk Hofschire: Either one of those things are plausible because, again, we don't exactly know the trajectory of the virus or the trajectory that's correlated to that of the economic downturn until we get until certainty on those things. A sort of typical recession playbook to me seems appropriate that you're going to want to stay a little more cautious, a little more defensive, more diversified with some defensive assets in the portfolio.
Chris Dillon: A little bit different from T. Rowe Price's perspective. One of our former chief investment officers named Brian Rogers. His quote was the world doesn't end very often, and we don't think the world is going to end this time. You had mentioned, Dirk, The point about recessions being good entry points, I think our base case is thinking about Q3 as green shoots, and we need to think about the world as it's going to look 6, 12, 18 months. Without it being an aggressive move, I would say as a firm, and I sit in multi-asset at T. Rowe Price, $340 billion-plus of our trillion dollars in assets. We have been methodically incrementally adding to our 60% global equities, 40% global fixed income framework.
Chris Dillon: I'd say we're about 63.5% on global equities leaning into this methodically, taking advantage of the opportunity, almost dollar cost averaging, if you will. I'd expect us to be getting to the extent that there's more weakness, more volatility, and we test the lows back to the 2000-ish type of framework, our thinking of this being somewhat deep but somewhat narrow in terms of breadth of the recession. I'd expect us to be migrating to a 65% equity stance in multi-asset.
Chris Dillon: I would say for those portfolio managers at T. Rowe Price that have had dry powder and used that in terms of like, say, a more balanced fund away from T. Rowe Price multi-asset to the extent that there was a 20% cash sitting there at the beginning of the year. It worked its way down to 10% pretty quick. But I'd say, as we're testing the volatility in the markets right now, that's all being put into the market. We are thinking somewhat deep, but the breadth of it, and let's take advantage of the opportunity, thinking of the other side of the crisis. A little bit different from T. Rowe Price's perspective.
Tam McVie: Yeah. I guess from our perspective, I think we'd probably be on the more cautious side also. Clearly, if you take a strategic asset allocation framework, then, clearly, equities look more attractive now today. Actually, the US equity market still doesn't look that cheap. Obviously, the rest of the world looks cheap now. But that's if you're considering things from a pure strategic asset allocation perspective. There are some very long-term investors, but there's not actually that many of them, particularly just the way the reporting is done, the way people have instant access to their capital, and they generally, behaviorally, don't like going through these types of scenarios.
Tam McVie: We would definitely see the outlook for equities coming into this year on a strategic asset allocation perspective was pretty limited to be honest with them. Our longer-term numbers were quite low with this. But with this significant and very, very fast sell off, we've seen those re-rated quite significantly. But, again, I think we're still on the more cautious side in terms of, potentially, you can start to step into markets cautiously. But I think if you look at even our tactical asset allocation framework or, in fact, our absolute return framework, we're sort of still on the cautious end.
Tam McVie: We do see some opportunity in terms of longer-term returns and long-term opportunity in areas like investment grade credit, for example. In Europe, spreads have moved out very, very aggressively. There will be defaults, whether that's in the IG space or not, I don't know. It is probably more likely that those companies will fall down, and we've already talked about fallen angels. But in the pure IG space, it looks like it's a reasonable opportunity, but that's more to do with dispersion as opposed to stepping into risk.
Tam McVie: The other area you could probably talk about in terms of stepping into taking advantage of some of the dispersion would be in just equity volatility. If you could just look at something like the VIX index as an indicator of that, clearly, incredibly high levels, last seen in the financial crisis. But if you're willing to take the other side of that, then, again, on a multi-year timeframe, that probably looks like a reasonable thing to be doing in conjunction with a highly diverse portfolio. But from our perspective, that leaning into price dispersion as opposed to leaning into kind of more active risk taking, we're still holding a lot of liquidity.
Tam McVie: I don't think we're convinced that some of the liquidity issues we were talking about at length, there's some positive action which will ease them. I'm not convinced that they've gone away altogether. We're holding on in cases actually increasing liquidity. That's partly because margin falls from derivative markets have increased also. To that point, we're probably that slightly more defensive viewpoint, albeit we can see for that truly long-term investor, equities outside of the US are not cheap. US cheaper, but still on a relative basis, less so.
Chris Dillon: I think we didn't mention US Treasuries at all. Obviously, a diversifier that worked well year to date. But I think just one final point on the subject, and we could go in different directions here as we wrap up our conversation, but I think one thing, we've added $2 trillion stimulus to the extent that there's more on top of that. There is going to be a lot more treasury issuance. I think it's worth thinking of a 10-year treasury yield that, during the week of March 23, settled into the range of 70 basis points after being as low as 30 basis points, after gyrating all the way up to 123 basis points, seemingly settling in around 70 basis points.
Chris Dillon: What we do know off of the response to COVID-19 is a lot more treasury issuance is coming, and there is a fiscal premium, if you will, coming to US Treasuries. I think that's one thing that gives us some reticence in terms of the diversification you get from treasuries, and the coiled spring that duration risk can potentially present to investors at this moment in time.
Tam McVie: I'd agree with that point around ... It's also quite specific to the US Treasury market. I think flexibility is probably quite important in going forward. Again, on a backward-looking basis, just 60% in S&P and 40% in treasuries over the last 10 years. You've probably done quite a good job, actually. On a risk-adjusted basis, it's performed incredibly well for you. On a go-forward basis, for us, that probably means the need for flexibility. We probably agree with you in terms of the viewpoint you just presented on treasuries. But, actually, markets like Sweden or Australia actually have some interesting opportunities from a duration perspective. Being able to take short positions and actually take advantage of some of the areas of the markets that are much more affected by the economic fallout that we're kind of going through.
Tam McVie: Then, also, I mean, also some clients may well look to precious metals as well as a potential source of diversification going forward. I guess the key thing from our perspective would be that ability to have a flexible mandate is going to be important, because we do believe it, and we believed it before this crisis. But we do believe that this next decades, being a bit more granular, having more flexibility around your mandate in terms of breadth of coverage and being able to access different markets is going to be more and more important as we've seen these regime shifts come through the last decade, and you expect them to kind of continue as we go through the next.
Jenna Dagenhart: I'm glad you brought up treasuries, too, because some of these moves really have been very astonishing, as you said. I mean, getting into 30 basis point territory, that's 100 basis points lower than the previous record. Anything you'd like to add here, Dirk, in terms of fixed income, treasuries?
Dirk Hofschire: I mean, in the near term, again, I think treasuries reacted like they were supposed to in a risk-off environment, and they were sort of the only thing that held up there for a while. But I agree with and would echo some of these comments. I think there's a potential here for regime change of the way things have been over the past 40 years. Part of that is just math. We're not going to go into negative interest rates. There's only so far yields can fall from here, and only so much diversification that's going to provide, and then you throw in all the fiscal issuance on top of it.
Dirk Hofschire: To me, it's not even just about the supply-demand for treasury paper. It's also about the combination of extraordinary monetary and fiscal experimentation happening at the same time. This is something we haven't seen before. Yeah, we had a big deficit going into this, but it was mostly tax cuts and tax cuts for corporations, tax cuts for wealthy that really wasn't being spent. If we start borrowing trillions more on top of that and giving it to lower middle-income tiers, giving it to hospitals, spending it, giving it to state entities that are actually going to spend this money dollar for dollar, have a higher multiplier, it's very probable that this experimentation at some point is going to raise the nominal level of GDP.
Dirk Hofschire: I don't know if it gets to higher real economic growth over time, it depends on how we spend the money. But the nominal pace of growth is probably going to go off, in which case, it's going to be increasingly incongruent with a 10-year treasury yield below 1%. The Fed almost has to keep rates down there. But if we get inflation, you can certainly see a regime change in the market where treasuries are not necessarily going to be the diversifier that they were. It's a lot harder to get diversification in a higher inflation or a rising inflation expectations environment. Some of the comments already made around precious metals and other ways of getting diversification, having flexibility, I think, are going to be extremely important.
Jenna Dagenhart: I think the burning question is, where do we go from here? As we wrap up this panel, I want to get your thoughts on how we move forward from this. Dirk, do you want to kick us off?
Dirk Hofschire: Yeah. I mean, I go back to start with your time horizon. Long-term selloffs are actually very beneficial from the standpoint that we were at very high asset valuations across the board. Now, besides treasuries, everything's gotten cheaper to a reasonably significant degree. When you look at places like municipal bonds, you can see baby getting thrown out with the bathwater from the standpoint that that's really sort of a technical near-term liquidation phase. Not really saying anything that the spreads of muni should be at their dramatic wide indefinitely.
Dirk Hofschire: I think in that long-term opportunity, that's the best place to always start your investing, start your strategic asset allocation, your glide path, all of that. That's the most important. I think when you come back to the really near term, it's important in this environment to realize we are probably going to have more volatility because we have more uncertainty. That's part and parcel of markets over time. We're going to have an extra dose of it for at least the next several weeks, maybe several months, and maybe for longer.
Dirk Hofschire: It's not a terrible thing. But I do think at this point, you want to remember what you sort of know and what you don't know, what you sort of thing you know, make sure that you actually have some confidence in it before you make major changes in your long-term asset allocation one way or another, because this is still a period that I think is extremely unsettled and does mean that we're going to bounce around more than we might usually.
Jenna Dagenhart: Chris, any thoughts from you on where we go from here, what the recovery might look like, anything you'd like to add?
Chris Dillon: Hard, obviously, to forecast amid such uncertainty. I don't think we're going to do that from T. Rowe Price's perspective. But I think what is our control is thinking about, based on incidents of success, China, South Korea, things we've talked about, even Italy, we are of the expectation the back half of Q3 things start to look better. Once things stop getting worse, then decisions can get made. I think it's just a couple of simple messages that we're adhering to. Communicating with our clients is one. Stay invested. Count on active managers to deploy assets accordingly. That will happen.
Chris Dillon: Security selection is going to matter a great deal. But I think what we learned during the week of March 23rd is it won't be weeks or months when markets figure out, we've seen a bottom, there is another side to this. It will be in a matter of business days, which gets back to the idea of staying invested. Think long-term. I think from our perspective, its stocks are cheap. If they are attractively valued here, if you're thinking 6, 12, 18 months and beyond, we have to take advantage of this opportunity.
Chris Dillon: Diversification absolutely matters. Thinking of Asia Pacific as a diversifier here. Those valuations are absolutely cheap. Even thinking if there is a U on the other side, small caps have taken an absolute beating here. Let's not leave small caps. But security selection matters again a great deal. I think stay invested, think long-term, be diversified, active management matters. Those are messages we're conveying in the marketplace right now.
Jenna Dagenhart: Tam, how about you? Anything you'd like to say in closing?
Tam McVie: The base cases is one where we're still assuming, as Chris kind of just alluded to, is that kind of U-shaped recovery. I guess, for us, we do still have concerns that the downside case is probably considerably more likely than an upside case from that kind of U-shaped recovery. We're certainly looking for the kind of improvements and kind of improvements from a health perspective and some of the numbers to drop in this kind of health crisis. But the flip side being is that with the dispersion, with price dispersion that we've seen created in market, that does create opportunity.
Tam McVie: Again, I'm probably just echoing what other guys have been saying in terms of then that comes into your timeframe longer term. We might see this. This might be a buying opportunity. But I think, certainly, our portfolios are still looking for ways to take advantage of the price dislocation without risking aggressively in the short term, again, being thoughtful as to when we might be able to catch that term.
Jenna Dagenhart: Well, gentlemen, thank you so much for joining us. We could go on all day because, as you've said, we don't know where we're going from here. A lot of uncertainties right now. All very timely conversation. Thank you.
Chris Dillon: Jenna, thank you.
Dirk Hofschire: Thanks for having me.
Tam McVie: Thank you.
Jenna Dagenhart: Thank you for watching this market volatility and economic uncertainty masterclass. I was joined by Chris Dillon, multi-asset class strategist at T. Rowe Price; Dirk Hofschire, senior vice president, Asset Allocation Research at Fidelity Investments; and Tam McVie, multi-asset strategist at Aberdeen Standard Investments. I'm Jenna Dagenhart with Asset TV.