MASTERCLASS: Fixed Income & LDI - October 2020
September 30, 2020
Jenna Dagenhart: Welcome to Asset TV. This is your market volatility masterclass. The coronavirus crisis has closed down schools, businesses, and several segments of the economy and global markets are experiencing wild swings across the board. Joining us to discuss this historic volatility, we have three expert panelists: Tom Wald, Chief Investment Officer at Transamerica Asset Management; Malcolm Polley, President and Chief Investment Officer at Stewart Capital; and Tracie McMillion, Head of Global Asset Allocation Strategy at Wells Fargo Investment Institute. Everyone, thanks for joining us.
Malcolm Polley: Thanks for having me.
Tracie McMillion: Good to be here.
Tom Wald: Nice being with you.
Jenna Dagenhart: Yeah. Great to have everybody joining us remotely for this very timely panel. The VIXs spiked to record levels. And it goes without saying that this has been a pretty historic two months for the markets. Tom, what do you believe it is most important for investors to recognize right now?
Tom Wald: Yeah, I mean, probably a few things. I think first this really is history that we're living through right now. I mean, the COVID-19 crisis really is a medical, economic, and societal black swan, the likes of which the few people alive today can really attest to. And we are looking into right now probably the worst quarter of economic contraction going all the way back to the 1930s.
Tom Wald: I mean, levels of GDP, unemployment, housing data and corporate earnings that would really be unthinkable just a couple of months ago. Now, the flip side of that is we are staying put in place. Now, unprecedented levels of monetary and fiscal stimulus that will total in the several trillions of dollars, and that's going to probably be a very important bridge as we work towards an economic recovery here.
Tom Wald: And of course, the medical data continues to evolve on COVID-19. And of course, it goes without saying, our hearts go out to everybody who's been impacted by the virus. And we may be seeing some indications that we are getting through the worst of the new cases, the unresolved cases and the fatalities. So, when you put this all together, I think investors should also remember that the market is the great discounter of future events.
Tom Wald: 00:02:34 And if it looks like a recovery might be in place, the market will probably react to that even if that recovery is ways out in the future. But volatility and uncertainty are going to continue in the months ahead, and that's something investors need to know as well.
Jenna Dagenhart: 00:02:50 Yeah. Tracy, how would you summarize the current environment? It's certainly an unprecedented time, as Tom mentioned.
Tracie McMillion: 00:02:56 Sure. Yeah. So not to where we put a lot unprecedented. And it seems like almost every day we point to one asset class or another and we say, "Well, that was an unprecedented move." We see commodities markets, the oil market's going into negative territory for the first time. We've seen swift movement by both the Federal Reserve and by law makers to bring in that fiscal stimulus very quickly this time.
Tracie McMillion: So lots of moving targets, moving events for investors to sort through. And so, it's really been a tricky time for investors. So, we're telling investors to go back to the basics. Think about how much cash you have on hand. Do you have enough to get you through a period like this? Do you have the right time horizon for your investment portfolio? Do you have the right level of risk in your portfolio?
Tracie McMillion: Has the market rebalanced the portfolio for you, and do you need to go back in and make some adjustments? So, it's those types of questions that we believe investors need to be asking themselves right now. Is your portfolio positioned the way it should be for the amount of time that you have left before you need to start using that portfolio?
Jenna Dagenhart: Yeah. A lot of firsts and a lot of volatility. Malcolm, you see volatility as an opportunity. Why?
Malcolm Polley: Well, it's kind of a function of how I got into this business. This is now I guess the fourth market dislocation for the bear market I've experienced in my career. I had the good fortune of starting on Black Monday, 1987. I didn't think so at the time because I started on the sell side. But what it's trained me to realize is that market volatility can certainly help you. What happens is people tend to react before they think.
Malcolm Polley: I say its kind of the ready-shoot-aim philosophy. If you do any shooting of guns or other weapons or anything like that, you know that ready-shoot-aim is not the proper sequence. And if you use that sequence, you miss opportunities. So, volatility really creates a lot of opportunities because people throw up their arms and run, screaming around and thinking the world's coming to an end, the world's coming to an end and sell off everything indiscriminately.
Malcolm Polley: And for us, particularly as value managers, we like that. I mean, people think I'm weird. I enjoy it when the market goes down because then it creates opportunities for us to invest particularly in very good businesses that we might not have had an opportunity to own for a while or in the past at all. And if you understand what it is that you're buying, that the thing that we're going through today, as bad as it is, is a point in time, then you can use that to your advantage because time is a friend of investors.
Malcolm Polley: The market won't end tomorrow and the world won't come to an end tomorrow, at least we hope not. And so time works in our favor and we have the ability and the opportunity to use the dislocation in price to buy good assets much less expensively than we could a day ago, a month ago, a year ago and end up with much better investment returns in the process.
Jenna Dagenhart: And I don't think you're alone in that. I saw an interesting study about how millennials see a volatility and drops in the market as an opportunity as well.
Malcolm Polley: Right. I mean, it's interesting. In many ways, our view on the economy in the world is a function of how we grew up. And if you think about that, we baby boomers have basically known expansion all of our lives. We've gotten pretty much whatever we wanted as the market moved in our direction, as we bought stuff and acquired houses and built our investment portfolios. And now we're nearing retirement, so we need to try and have some assets to invest in.
Malcolm Polley: We really, until lately, have not experienced these major dislocations that we've experienced really quite frequently over the last two decades, unlike the millennials who were born in one of the worst recessions and one of the worst market dislocations in history, grew up to see the worst recession since the great recession, and now we're being faced by a medical pandemic, the likes of which we have not seen in a hundred years.
Malcolm Polley: So they are really definitely colored by their environment. And in many ways, millennials today from an investment standpoint, from a behavioral standpoint, really look and behave a lot like my parents that grew up during the great depression. They were impacted to a great degree by the worst economic calamity in generations, much like the millennials are today.
Malcolm Polley: My parents were voracious savers. Millennials are voracious savers. It may not necessarily show up as much because they don't earn quite as much as we boomers do, but their habits have really been colored by the impact of these major economic and market dislocations over the last 20 years.
Jenna Dagenhart: I know we've seen a lot of red and circuit breakers triggered. But Tracy, as you point out in your most recent research note, volatility works in both directions.
Tracie McMillion: It does. That's right. And timing the markets is very difficult. We often look at the best and the worst days in the markets, and what we had seen in that research: over the last 30 years, if you missed the best 30 days, then your returns would have been less than 1%, and that's compared to over 7% in the S&P 500 if you just stayed invested.
Tracie McMillion: And it was interesting that the number one and the number two worst days have occurred during this downturn; they were 316 and 312, but 313 was one of the best days, the fourth best day in the last 30 years. So, oftentimes, the best days are intertwined with the worst days. So, it's really hard to sort out those worst days and to be in the markets for the best days.
Tracie McMillion: So staying in the market the entire time does provide you with a simple way of making sure that you're in the market for those best days rather than trying to surgically fill out those worst days. So yes, there's opportunity to this volatility. And volatility works both ways. It can be those big negative down days, or it can be those really big positive up days that over time keep your assets growing.
Malcolm Polley: It's interesting because I've seen a lot of questions from even coworkers saying, "Well, should I stop contributing to my 401k? Should I pull out of the market today?" And what I've been telling them is, look, if you think about it, in many ways you should be doing the exact opposite. If you were putting money into your 401k plan, your dollar cost averaging.
Malcolm Polley: So now that the markets are down fairly dramatically, you're buying assets much less expensively than you were six months ago. And so, you're buying a whole lot more for those dollars that you invest than you were six months ago. So, it works out to your favor if you stay in.
Jenna Dagenhart: Yeah. Certainly, no way of telling if we're going to see more downside or more upside. Tom, do you think that stocks will likely revisit the lows that we experienced in March, and is that something that long-term investors should be focused on?
Tom Wald: Jenna, that is a great question. And for no other reason, that is the one question I've probably gotten more than any other over these past several weeks. Do you think we'll go back and retest those March 22nd lows? And there is this school of thought that bear markets have to go back and retest initial lows before they can move forward. In this case, I'm not so sure of that.
Tom Wald: Those lows occurred back before both the fiscal stimulus CARES Act was in place, and really before we knew to what degree the fed was really going to go forward in terms of the high degree of the monetary stimulus they were going to put forward as well. That having been said, I think trying to call a market bottom, especially in an environment such as this one, really is kind of a full, right?
Tom Wald: I mean, markets can always go lower based on emotion and various other short-term factors. But I think what's really most important and what we're trying to tell investors is focus less on trying to call a bottom and try and identify long-term entry points based on criteria that you think can put the odds in your favor in terms of long-term returns that will be above average levels historically.
Tom Wald: When you take that approach and say, well, let's look at a lot of factors here. Let's look at what's happened in previous types of bear markets. Let's look at what has been a comparison of stock valuations and dividend yields to current long-term interest rates as well as what could conceivably happen after the stimulus was put into place.
Tom Wald: I think you can begin to make the case for long-term investors that you can be buying it at this entry level and have a pretty high probability of long-term returns that will be above average terms of what the market has put forward historically.
Jenna Dagenhart: Dow 8,500 seems like a long time ago and so does Dow 20,000, but we've revisited that during this recent volatility.
Tom Wald: Yeah. And so, I think if you're constantly trying to look at what might be the bottom in the markets to try and invest, I think you probably miss the opportunities as to what is really an attractive level going forward over the long-term. That's really where I think the value is in terms of identifying points to get into the market or points to stay in the market and possibly increase your overall equity weightings.
Jenna Dagenhart: Malcolm, any thoughts on your end about the dangers of trying to call the top or the bottom as a T? And what role does investor behavior play in all this?
Malcolm Polley: It has been said by both Tom and Tracie, trying to call tops and bottoms is difficult at best. You're better off in trying to find a return that you're trying to achieve as an investor than trying to call a top and a bottom. I mean, look, if today is simply a point in time, if you smooth it out through history, it becomes a blur. You don't really notice what's happened today.
Malcolm Polley: If you look at a long term chart the Dow Jones Industrial Average or the S&P 500, other than major dislocations like happened in the great depression and the blips that you had in 2008 and 2000, 2002, you really don't see the daily noise that exists, and that truly is what it becomes, is noise. So if you can filter through the noise and pay attention to the valuations that you're buying, if you're buying at a good valuation so that the return you get as an investor over the long term is above average, then you shouldn't really concern yourself with trying to find the exact top and the exact bottom.
Malcolm Polley: Because as Tracie said, if you miss it just by a small amount, it can dramatically negatively impact your long-term return. And since we're long-term investors, we shouldn't be concerned so much with the daily noise of the daily moves. Trying to get that your best long-term return is what you should be after.
Jenna Dagenhart: Yeah. To that point, Tracie, would you say that investor overreactions such as steep selling before recovery and missing out on gains like we talked about can be just as dangerous as the market sell offs themselves, which are often pretty short lived?
Tracie McMillion: Oh, sure. Most definitely. What you see happening is you see that investors are often wanting to sell out at the very worst times, and they want to buy in at the worst time to buy. So oftentimes they want to buy high and they want to sell low because that's your natural inclination. If you're worried about what's going on in the market, then you may want to lighten your equity position or other risk assets in the portfolio.
Tracie McMillion: And oftentimes that just turns out to be the exact opposite of what you should be doing. So, one way to combat that is to have a rebalancing program in place, where you've decided in advance what you want your allocation for your portfolio to be. And then when we go through these periods, where there's a lot of market dislocation or a lot of market volatility, then your portfolio adjusts to that volatility.
Tracie McMillion: It drifts the way from where your target is. And in fact, we look at the market drift that had happened from the end of the last recession until the beginning of this bear market. And if you were in a 60/40 portfolio, your equities had grown to over 80% rather than your target at 60%. So, if you were not rebalancing along the way, you went in with a lot more risk than you had intended.
Tracie McMillion: But if you're rebalancing along the way, then you're selling out as those assets go higher and you're buying into the lower priced assets within your overall allocation. So, it's a more uniform way of dollar cost averaging and it's a uniform way of buying low and selling high, which is exactly what you want to be doing.
Malcolm Polley: I guess another way to think about trying to find tops and bottoms is, as Buffet has said, you need to think of the market as a partner and your market as your partner suffers from bipolar disorder. And day to day, he's either very ecstatic about what's going on or very depressed. Because when he's depressed, he will sell you his entire ownings at ridiculously low prices.
Malcolm Polley: And so your job is to buy them when he's trying to sell them to us. And when he's up, when he's not a manic state with his bipolar disorder, he will buy everything that you own at ridiculously high prices. So, your job as an investor is to determine, is he manic or depressive? And play against what his feelings are.
Jenna Dagenhart: Yeah. Tom, what kind of characteristics do you think that investors need to have in this sort of market environment?
Tom Wald: Yeah. I think a couple of ones I've been trying to convey. I think this is really a time for investors and for portfolio managers to be prudent and to be opportunistic. And we don't see those two as being mutually exclusive. This is not a zero-sum game out there. And COVID-19 has clearly created a new set of risks that need to be taken into account, but also has created a new set of opportunities as well.
Tom Wald: And I think it's kind of reset the playing field to some extent, but it also has reiterated the fact that investors need to look at those two characteristics, being prudent and being opportunistic, as really their obligation in managing portfolios in these sorts of markets. And I think ultimately this is going to bode very well for active managers.
Tom Wald: Because in an index, you're looking at things that are just being marked up and marked down on a daily basis without any kind of real consideration as to what should be the larger portions of the portfolios right now. And I think what's going on these last couple of months is really going to enable active managers to really differentiate themselves from the indexes and probably in a way that we haven't seen in some number of years. So, I think that's really kind of the characteristics of what are really going to be the types of outperforming portfolios that investors should be looking for in the days ahead.
Jenna Dagenhart: No one said you can't be both a prudent and opportunistic.
Tom Wald: Yeah. I think it really works both ways. Those with a fiduciary responsibility to really act at the best interests of their investors really need to take both characteristics to heart right now, because I think that's really what investors are looking for in them right now.
Jenna Dagenhart: And Malcolm, we've talked a little bit about dislocations. I wonder if you're finding mispricing’s and dislocations, and do you think markets are really efficient?
Malcolm Polley: Are markets efficient? That's kind of a loaded question. I teach in a class in a local university, and one of the things that we talk about is the efficient markets. There's three pieces of that. There's the strong form, the weak form and semi strong form. The strong form basically says that the market prices reflect all historic information, all current information and all other information, whether public or nonpublic.
Malcolm Polley: In our mind, if that were true, I don't think you would have the dramatic downward moves or dramatic upward moves that you see in markets or securities as they react to information. I mean, Tom was right, the market is a discounting mechanism, and it can only discount that which it knows, known knowns and known unknowns, if you will.
Malcolm Polley: What creates the problem and where I really believe that the problem of market efficiency comes into play is when you have the unknown unknowns like COVID-19. When they hit the market, the market then reacts instantly and then sits back and says, "Hmm, maybe I overreacted to that information." So, while information gets instantly reflected in prices, it's not necessarily instantly, accurately reflected in prices. And you get investment opportunities that are thrown out regardless of the quality of the company.
Malcolm Polley: There used to be an old line in the investment business, how do you make $1 million from the airline business? And you start with $2 million, because for a long time the airline industry was a net money loser. But you have an instance today in a business that we have, until fairly recently, never made an investment in, where you've got clearly much superior operators and much more superior balance sheets amongst some of the operators and they've all been treated in the same manner.
Malcolm Polley: And so opportunities are created because we as investors can take the time to sit back and look at the financial statements generated by these companies. How much liquidity do they have? How bad do we think it's going to be in terms of how long are they going to be out of commission until they're earning revenue and planes are back in the air? And can we then reasonably expect that once things get going, that they'll be able to generate an acceptable investment return?
Malcolm Polley: And I think in some instances the answer to that is clearly yes. And so, we as investors have the opportunity and benefit during these dislocations to weed through the noise, weed through all of the things that have been thrown away to find those good quality businesses that have been treated equally as poorly as bad quality businesses. And so, our focus really has been on clean balance sheets, cash on the balance sheet, cashflow generation.
Malcolm Polley: Are their earnings going to be able to be maintained in this type of difficult economic environment? And can they take advantage of some of the opportunities that are clearly being presented because of this difficult economic time? And I think that we as investors can find lots of opportunities. I know that we certainly have.
Tom Wald: Along Malcolm's point, I've always taken the point of view that efficiency is a goal of the markets but not necessarily always a given. And that you will have times, as Malcolm said, where there will be opportunities based on the market reaction that perhaps is trying to incorporate information that may not be complete or wholly accurate.
Tom Wald: But over the course of time, the efficiency goal of the market [inaudible 00:25:17] that ultimately will coincide with value. And when those two get out of [inaudible 00:25:27], that is the opportunity for investors. And the more volatile the markets become with the last total amounts of information necessary to determine that efficiency, the more the opportunity is for investors and portfolio managers.
Malcolm Polley: I agree.
Tracie McMillion: Yeah. And I was just going to also add that I do think that this is a very good example of market efficiency given what we know. But the markets are acting on imperfect, incomplete information. And it's really only over time that we get more of a complete picture and markets can be more efficient over long periods of time. And that's really how we can do forecasts and how we can allocate assets.
Tracie McMillion: Because we assume that over long periods of time, markets are more efficient and that those where you're experiencing more volatility, you're experiencing more risk in those markets, they tend to pay you more because investors demand higher returns to endure that risk. So right now, markets are reacting to each daily headline and the information that we have is just very incomplete.
Tracie McMillion: So we may overshoot in one direction or another direction or both directions on consecutive days, and that's where you see all of this volatility coming into the market. But over time, you look at a long-term chart of the S&P 500, you see there are blips along the way, but it tends to move higher over time. And that's the longer-term efficiency of the market at work.
Tom Wald: You bring up a great point. And when you mentioned, I think you said your first day in the business was October 19th, 1987. You look at a long-term chart and that's kind of yes, the minute you're showing it to someone who wasn't in the business back then, which most people were not, it takes you a minute to point out that blip, but it's not wholly evident all these years later.
Tracie McMillion: Right. Exactly. And when we looked at the best and worst days, I'll just point out, that was the worst day since 1928. The single worst day.
Malcolm Polley: The day to get into the business.
Tom Wald: I think we all have very vivid memories of that day. And I'm going beyond the red just because I was studying the Cowboys on Monday Night Football that evening.
Jenna Dagenhart: And there've been a lot of mentions of a certain day being the worst day since 1987. We've seen a lot of those headlines. Tom, do you think that there are any historical parallels that investors can refer to in regard to COVID-19 and the selling?
Tom Wald: Yeah. I mean, great question. There's an old saying that history doesn't always repeat itself, but it often does rhyme. Something I've done over the last few weeks is I've actually gone back in history, which is really extremely interesting here. And I looked at what could be considered other black swan events over the past a hundred years or so.
Tom Wald:And a black swan event is defined as an unforeseen, an unpredictable event with severe and extreme consequences so COVID-19 clearly fits that criteria and we're clearly in a black swan event right now. So, what I did is I just sort of took my own judgment, went back and looked at similar types of events, going back to the early 1900s.
Tom Wald: And I came up with about a half dozen or so: World War I, the Spanish flu, the crash of 1929, early World War II in Europe, stagflation in the early 1980s, 9/11 and the financial crisis of 2008. And what's really interesting, in all those cases, there were very dramatic market reactions within that range above and below what we've seen with COVID-19, which is so far the worst has been about a 35% decline from February 19th to March 22nd.
Tom Wald: But in those cases, some are worse. The financial crises, the S&P dropped 58% from its high. And if you go back to the stock market crash in 1929, the 1932 low was down from 86% from there. But in all these cases, when the black swan was resolved, the following decade was quite favorable ranging, within all those examples I just said, from 7% to 16%. The average was 13% annualized over a 10-year period.
Tom Wald: So if you were to be invested in equities, specifically the S&P 500 a year at the resolution of the black swan prices and all those cases, you would have had about a three and a half times that amount of money 10 years later. So that sort of tells us, as painful as these black swan events can be and what we've seen with COVID-19, history does sort of indicate that if you are invested when those events are reconciled, the long-term prognosis really can be quite advantageous.
Tom Wald: And when you look at this COVID-19, I think there is a pretty strong case, and when you compare it to the others that I just mentioned, that the resolution could come sooner. And so that would tell investors maybe not to try and get out of the markets during this resolution period, but to be there at the point where we think there is a path forward.
Jenna Dagenhart: Yeah. Malcolm, what have you learned from history, and how does this black swan event compare to others?
Malcolm Polley: The interesting thing about black swan events is that, from a risk perspective and a volatility perspective, we as practitioners have tended to take them and believed since they happen so infrequently that we should discount them in their entirety when trying to determine the return path for our portfolios. Unfortunately, as we've learned over my career anyway, the black swan events happen with alarming regularity: they're just never the same event, hence why they're black swan events.
Malcolm Polley: Because the reaction is so bad, I think that we can't entirely discount and we need to keep them in the kind of the periphery of our vision and understand what could happen so that we can prepare for it. I know that particularly, as times get good, which we were seeing in the last few years, from 2017 and so forth when markets... 2017, you had basically no volatility in the market. The market was moving straight up.
Malcolm Polley: People assume that that will happen forever and that it can never get bad again. Ultimately, isn't that the purpose of a bull market and a bear market, to make you forget how good or how bad it got? A bear market is to make you forget how good it gets in a bull market. Get out of equities. I don't ever want to see them again. And in fact, clients of mine and people that I've known over my career that lived through those things and exited never got back in until it was too late.
Malcolm Polley: And conversely, people think that good times are going to roll and are going to roll forever. They tend to believe it's never going to get bad. For the most ridiculous extreme, I remember pulling my clients back in the late 1990s and asking them, what is the normal return on equity markets? And the answer I got was 25%. Well, we know that didn't work out really well. So that's extremely abnormal.
Malcolm Polley:And so our jobs as investors is to understand that economic and market history does not begin with the end of World War II. In the United States, we've got 200 plus years of economic and market history. We should know that in addition to expansion and recession, that wild contractions and yes, depressions have happened in the past. I mean, what we had in 2008, for example, was a good old-fashioned bank panic.
Malcolm Polley: Prior to World War II, they happened every 20 years with very regular occurrences. What kept it from happening is we now have central banks around the world that can provide liquidity so didn't get the depression that quite often happens as a result of that. And if you can keep that in the back of your mind and understand how things have happened in the past, you can begin to build a good idea of what things might look like in the future or at least account for all the probabilities and not just discount in their entirety the likelihood of a black swan event.
Jenna Dagenhart: Yeah. This black swan event will certainly be making the history books.
Malcolm Polley: Most definitely.
Tom Wald: I was just going to say, one of the other interesting characteristics of a black swan event is at time they're believed to be unforeseen and unpredictable, yet history looks back on them and then says, how could this not have happened? How could we not have known that World War was going to happen based on all the treaties of all the different countries in Europe?
Tom Wald: How could we not have known that a great depression in the 1930s was going to occur based on all the leverage that was in the stock market in the 1920s. And I'm sure 10, 20, 30, 40 years from now people will say, how could we have not known that COVID-19 was going to create a pandemic based on all the scientific data that was available at the time.
Tom Wald: Yet at that moment in time, it is an unforeseen and unpredictable event. However, history does try and teach us a lesson as to how these can be identified going forward. But often its difficult lessons to incorporate on a practical application.
Jenna Dagenhart: Yeah. Difficult to predict, but everyone likes to say, "Oh, how could we have not seen that coming?" And I've even heard people refer to what's going on with oil as a double black swan. Tracie, you talked about commodities earlier. Would you say that this is a double black swan given that oil is getting hit on the supply side and the demand side with coronavirus?
Tracie McMillion: Yes, I would. And just to go back a bit to what Tom was saying, it's interesting that we can look back at certain events and say, "Yes, we had ample warning." I think we can go back to the great recession and we can say we had warning there, we just didn't know exactly how it was all going to play out. We just knew that we were probably taking on more risk as a society than we should be in the real estate markets.
Tracie McMillion: And I think a lot of us saw that there was a problem, but we just didn't know how it was going to resolve. Whereas with COVID-19, we were sitting in our investment committees back in January and early February with our list of risks and our lists of opportunities and it wasn't on our list of risks. Whereas before in that great recession, a real estate bubble was on our risk list. And for the tech bubble, that was on our list of risks.
Tracie McMillion: Whereas this one just really seems to have hit the investment community from rough field. So, I do think this is a bit different in that regard. I'd say 9/11 was probably similar to that as well. But the way it's impacting different asset classes is very interesting because, as you point out, for the commodities, we have been in what we think is a secular bear market for almost 10 years now.
Tracie McMillion: And during secular bear markets, we often do see kind of this washout period where markets go easily down, and a lot of the marginal players are eliminated from that market and then prices can start to recover. Oftentimes, what happens is you do have over supply. Prices go up. You have over supply. Demand starts to diminish. If you have a recession, you've got both potentially a supply and a demand shock.
Tracie McMillion: This one, however, has been significantly greater than those that we've seen throughout history. So, I would agree with you that this is probably a double black swan for the oil markets. Not all commodities though because we're seeing gold move higher. So, there are again, selective opportunities within different asset classes here and investors need to be looking at that.
Jenna Dagenhart: And do you think the pandemic is impacting the way that people invest in general, and do you think there could be a lasting impact on say ESG?
Tracie McMillion: We do. In fact, we think that people are looking for those selective opportunities. And one area where investors say they don't know a lot about is in sustainable investing. And so, there's an opportunity for us to further educate investors about sustainable investing because it does match up with a lot of the goals that people have.
Tracie McMillion: Their top concern when they learn about the different ways that sustainable investing can promote cause is, they're interested in reducing pollution. And this is an event that has on its own reduced global pollution significantly. And so maybe there are some learnings we have from this event, where we can start to incorporate that into whether it's pollution control, whether it is helping to advance employee interests.
Tracie McMillion: And perhaps another way is that people might be more interested in governance of businesses and with more regulation and perhaps even governments investing in companies directly through the stimulus program. They could have more social issues that they are promoting and provide more opportunities for sustainable investment managers. One other point is that oftentimes people think they give up return opportunity if they invest in sustainable investing or ESG or if you're investing for a purpose.
Tracie McMillion: And our research has shown that that's not really the case. And since this bear market, we've actually seen sustainable managers outperforming probably because they're higher quality oftentimes and quality has been a factor in this downturn. But perhaps also because energy has been performing poorly so far this year and they often are avoiding certain types of energy companies. So, we do think this is a good opportunity for investors to take a look at sustainable investing.
Jenna Dagenhart: Malcolm, anything you'd like to add to that?
Malcolm Polley: I have mixed emotions. We have traditionally invested, and I've kind of followed a belief back in the days when I was selling, I used to listen to sales training tapes. And I used to listen to a guy by the name of Zig Ziglar a lot. And he said something that really struck a chord with me and that is, you can't do a good deal with a bad guy. And so, we've always taken a stance that we want to first invest with good people.
Malcolm Polley: And so looking at people in the manner and how they run their business is of extreme importance to us. That said, I don't know that we necessarily want the government to be telling us what we can and cannot do as a business owner. There are certain things that are the right thing to do, hiring minorities, hiring people, that kind of stuff because it's the right thing to do. But to necessarily have that codified in law in order to get funding sources, that's probably the wrong stick to use in my mind.
Malcolm Polley: I was in a boardroom as we listened to a regulator introduce the TARP money and it was interesting listening to them. They said, "We've got this great program. It's only for the best banks and you can't get it otherwise." And nothing bad is going to happen. We don't really know what the rules are going to be. And then talked with the CFO afterwards and I said, "I've understood that when a regulator asks you to do something, you probably should do it. But understand that the rules will probably change, particularly if you don't know what they are going in."
Malcolm Polley: So you need to go into it with your eyes open. I think that some of the things that they're asking in the safe act in terms of how you get dollars make sense. I mean, you don't want to take money only to cut loose employees. But I think we need to really look at how we make decisions on how businesses are governed. The idea that businesses shouldn't just manage for their owners.
Malcolm Polley: It’s the owners that are providing the capital and yes, we do need to pay attention to the places that we work and the places that we operate and take care of the environment around us. But as shareholders, we also should understand and hope that managers are managing those businesses for our benefit knowing that, in general, if we benefit, those around us also benefit.
Malcolm Polley: And it can be kind of a slippery slope so I'm always kind of concerned about how you answer. But I just think we need to be careful how we implement some of these programs that we don't overreach. And that's really the biggest danger, is that we overreach.
Tracie McMillion: Yeah. And I would definitely agree with that. There is a danger of overreaching there. I also think it's interesting though, if you just look at businesses that are operating in a socially responsible way, those businesses tend to do well relative to two other businesses that may not have that as one of their objectives. So, I definitely see your point, but I also think that there is an opportunity here for investors to identify their goals, and part of their goals can be that they want to make an impact. And you can do that now through so many different investment vehicles.
Malcolm Polley: That's what we're trying to do, right? We make investment decisions based on what our belief systems are as business owners and we tend to invest in those businesses that follow our belief structures. I think you have to be careful of how you define SRI and ESG because there are so many different definitions. How you define SRI, Tracie, or ESP may differ from how Tom defines.
Malcolm Polley: It may differ from how Jenna defines. It may differ from how I define it. And I may think that I'm doing well by investing with a company that may not meet a specific definition of SRI, but they are taking the effort, making the effort to become better corporate stewards and become better corporate patrons, if you will, and trying to improve their standing as opposed to just cutting on investment all together.
Jenna Dagenhart: And turning from ESG and doing a little bit of a deep dive on the economy here. Tom, what kind of economic criteria should investors be watching between now and year end?
Tom Wald: I think there's the traditional metrics that everyone's going to be looking at, everything from GDP and unemployment, which are just going to be horrific over these next few months. It's going to be the worst couple months for the traditional metrics, well-known metrics there. Other areas such as the housing data I think is going to be watched very closely.
Tom Wald: But I think if there's one thing that's going to be most important, everyone knows how bad this next quarter is going to be, how historically awful the second quarter is going to be. What I think the market's going to really be looking for is some level of sequential improvement in the economy in the third and fourth quarters.
Tom Wald: If we can get sequential growth off the second quarter, I think that's something that's going to be really important in the market. Because what I'm feeling is going on right now is the market is wrestling between what I call the depths in duration. We know it's going to be a historically awful second quarter economically, but is the market really going to be focusing on how bad it's going to be or how long we're going to be in this downturn?
Tom Wald: And if we can start to see that in the third and fourth quarters of this year, even though on a year over year basis it's got bad, that there's this sequential improvement over the second quarter. That's where I think the market can start to identify a path forward and start to have more of a favorable reaction. So, I think there'll be a lot of traditional metrics that we'll look at.
Tom Wald: There'll be a lot of focus on unemployment and GDP over the second quarter, but I think the trend is going to be very closely watch the second half of this year and that's really going to play a major role as to whether or not we start to see the market recover on a longer term basis.
Tracie McMillion: Yeah. Tom, we actually are thinking something very similar that, for the full year, it's likely that we're going to see negative GDP. But the second half of the year it's possible that we could start to see the economy recovering. But in the interim, very deep, very sharp recession, but hopefully very short. And once we get to the other side of that, then we start seeing consumers come back in, spending again and that hopefully gets us to a more positive number sequentially by the end of the year.
Malcolm Polley: And I would agree. And we have the benefit of a calendar on our side because for all intents and purposes, from the market perspective, at the end of June it becomes 2021. So, everybody's expectations will fast forward and flip the calendar and we'll be now no longer paying much attention on what happens from an earnings perspective in 2020, but what could happen and what the expectations are for 2021.
Tom Wald: Yeah. I would completely agree. I mean, earnings are going to have a handle on where corporate earnings are going to be for the full year and they're kind of going off what looks to be a really difficult couple of quarters. But I think the market will quickly focus, as Malcolm said, on 2021 somewhere around the midpoint this year.
Tom Wald: And I think that could be looking at your different kinds of metrics to get there and a lot of that could be the virus data itself: looking at what is the trend in new cases, the trends in recoveries, unresolved cases and fatalities. And that could help an investor determine if we're getting to "the other side of the virus" where the worst is over.
Tom Wald: And that's where some of these market experts from medical experts and institutes are looking at when we're going to see the peak level of rates and fatalities. And some of them have that peak level occurring in the next month or so, or even right now as we speak. And if that medical data starts to come down, I think that's going to probably bode pretty well for how the market and investors could be looking at the 2021 scenario.
Jenna Dagenhart: And what about the role of monetary policy and fiscal stimulus playing out in the markets for investors? Tom?
Tom Wald: Yeah. I mean, I think that cannot be overstated. I think that's a huge element here. I mean, if you just look at the numbers, $2.2 trillion in the CARES Act. A lot of that is directed immediately at small businesses, medium-sized businesses and large businesses. And also, at individuals as well, not just the direct checks they're getting, but some of the unemployment benefits as well.
Tom Wald: And all of that is meant, in my opinion, to be a bridge. It's a bridge to recovery. If we can keep the economic damage down to manageable levels for individuals and for small businesses and medium and large sized businesses as well, that then creates the bridge. And what's really interesting here is I don't think the fiscal and monetary stimulus are going to go away when we get a recovery.
Tom Wald: And then that bridge could conceivably be a tailwind when we start to get to the recovery, and that's where you could start to see a very favorable environment for the markets. On the monetary policies, I mean, I think it's just fascinating when you look at what the Federal Reserve is doing here, not just in terms of taking rates back down to a zero interest rate environment, but what they're allocating to the large scale asset purchases. If you go back to the previous precedent of the financial crisis in 2008, where they wound up purchasing bonds in the open market of $4 trillion over the next six years.
Tom Wald: I mean, they're going to blow past that level in terms of the amount of dollars spent in the open market purchasing, not just what they did before in terms of treasury and agency mortgage-backed securities, but also in the corporate markets, the high-yield markets, the commercial MBS markets, the municipal markets and also what they're doing in terms of credit facilities to purchase the loans that the banks are going to be making to the small businesses.
Tom Wald: And the analogy I like to make, if the Federal Reserve got through the financial crisis using cannons, this time around they're using nuclear warheads.
Tracie McMillion: Yeah. I would agree with that, Tom. And the way we're kind of looking at that is, if we've got a really deep but quick recession here, then we can fill the gap with the fiscal stimulus. But the question then becomes, does it extend out longer than what we expect? And if that's the case, then we think markets will start to rethink their positioning right now.
Tracie McMillion: We have quickly come back 26% from the low point and that is an anticipation of better economic numbers six months out, as you put it, now come that market if we're looking ahead about six months. But if we should start to see a resurgence in cases, if we start to loosen up some of the restrictions that we have today and then people start getting sick again and we have to reimpose those, then I think all bets are off because we've extended that recessionary period and it's going to be more difficult to fill the gap for a longer period of time.
Tom Wald: Yeah. And what's interesting, if you look at Spanish flu pandemic of 1918-1920, there was a second wave that occurred about halfway through what was believed to be a recovery period. And of course, they did not have nearly the containment efforts, anything along the lines of what we had now. But I think that is something that needs to be taken it into account and watched very closely. Even if we do start to see better medical data, you do have to wait for that potential second wave might hit us again.
Tracie McMillion:And the good thing is, there are several countries ahead of us at this point. We can watch what's happening in China. We don't know if all that data is perfectly accurate, but we can watch what's happening in Europe and we can see as they start to reintroduce business activity into their economies if that goes smoothly. And I think markets can take a cue from that as well.
Malcolm Polley: I think that ultimately what we don't know is the true incidence of infection because we haven't been testing everybody. We don't know the people that had COVID-19 and didn't display symptoms or very strong symptoms. We don't know how many they have infected. I always had believed since the beginning that the initial estimates on infections and death rates were wildly too high.
Malcolm Polley: It looks like that's going to be accurate. And I think that one of the things that we will find is that far more people ended up having at least some version of COVID-19 and now have antibodies in their system so that they should not get it again. And ultimately I think it will be the testing of people as we come back to work, whether it's in the United States or Europe or what have you, to determine whether or not they have antibodies present that will allow us and give us the opportunity to feel more comfortable about going back to work.
Malcolm Polley: And ultimately, I think one of the things that we will see is people's behaviors are going to change. I know historically when I flew, if I was in an airplane and I saw somebody with a mask, it was probably somebody from Asia. It tends to happen more frequently over there. I think we're going to see it more frequently here in the United States as people just learn to take protective measures to avoid trying to set off further problems, which ultimately is not what happened in 2018.
Malcolm Polley: People got tired of being indoors. They went outdoors, had big celebrations, and it created another problem. I think if we've learned anything from history, that maybe it.
Tom Wald: And I think there's some data that we're starting to see that's suggesting exactly what you just said in terms of how many people have really had COVID-19 maybe in an asymptomatic fashion that isn't showing in the data just yet. We're starting to see that occur as well. And if there's one stat I'm watching every night, and I'm not a doctor, I'm not a medical expert, I have no experience in care, it's really the percentage of recoveries to total cases.
Tom Wald: And that's really where some countries in Europe are really showing some excellent progress. Germany for one as an extremely high recovery to reported cases ratio. If I had to pick one stat to watch that could maybe make the argument for reopening the economy, I think that that's really the one that I'm watching, one with a lower fatality rate.
Jenna Dagenhart: Really interesting. And as we discussed today, there's a lot of headlines going around, economic data, fiscal stimulus, monetary policy. Some of those numbers that you just mentioned too with the recoveries. How are you communicating all these developments to clients, Tom?
Tom Wald: Well, we're trying to get as much out there as possible. I write a lot of blogs on the Transamerica website. We have a monitoring market page. We also have a market outlook page. In addition to my economic and market perspectives, we also provide some healthcare perspectives as well. We've also put out a series of podcasts.
Tom Wald: We think in this environment you just can't get these messages out fast enough and efficiently enough to really keep up with the day to day developments that we're seeing. But it's a great challenge and one that we love tagging on because this is really an unprecedented period of time, one that we feel that companies investing client capital really need to get out with these messages as quickly and as often as possible.
Tracie McMillion: Yeah. We completely agree with that. And in any time of uncertainty like this, clients just want to know what is happening. So, we've been doing regular client calls. We've been putting out publications every single day and we've really ramped up the communication. And we've heard back from clients that it's been very helpful, and it's allowed them to maintain their long-term allocations. And that's exactly the goal, is not to make any sudden changes to your portfolio that might be detrimental on the other side.
Malcolm Polley: I agree. Communication is key.
Jenna Dagenhart: Malcolm, any final thoughts on your end as we come to a close here?
Malcolm Polley: I mean, people look at volatility as problematic, and it certainly can be. But we've really chosen to look at volatility as an opportunity. And I think if you can change your reference, if people work on changing their frame of reference to make decisions based on longer term expectations or longer term goals, then they'll have a much better base upon which to make a decision, not just knee jerk, "Oh, the world's coming to an end."
Malcolm Polley: But my opportunities are now far greater than they were six months ago. I have a lot more opportunities, and in many cases, better quality opportunities today that will probably give me better, longer term returns than they would have six months ago. So, take some time to sit down and think about what you're trying to accomplish and then use the opportunities around you to do that.
Jenna Dagenhart: Tom, where do we go from here? Any final thoughts on your end?
Tom Wald: Yeah. And I think what's really interesting is we've just experienced the fastest 35% decline in the S&P 500 in history that occurred from February 19th to March 22nd. And that was, in my opinion, the markets looking at what we're talking about right now. That was the market's looking at just how brutally impacted the U.S. and global economy was going to be there. There's an old stock stake, the escalator up and the elevator down or some people say take the stairs up and the window down.
Tom Wald: But along those lines I think we've seen this sharp sell-off in the market. Since then, you're starting to look at what is potentially on the other side of the virus. And I think as the medical data and the economic data improve in the second half of the year, I think that continued improvement could be what the market will see in a continued favorable reaction going out to 2021 and beyond. So those are all things that I think investors need to take into account when we're starting to look at what really will be the catalyst for an improving economy and an improving market.
Jenna Dagenhart: Tracie, anything from your outlook you'd like to highlight moving forward?
Tracie McMillion: Yes. So, it certainly has been a very difficult year so far and we're only a little more than a quarter into the year. But remember we started the year with a lot of economic strength, and we started the year on a positive note, and we have been hit with a sudden shock and that shock was reflected in market volatility. But we do seem more progress treating the virus, progress towards a vaccine eventually.
Tracie McMillion: And as all of that starts to be factored into the markets, we definitely see opportunities here and more opportunities probably in the U.S. than internationally. So, if I leave our listeners with anything, it's that we would go up in quality and we would focus more on the U.S. than international at this point.
Jenna Dagenhart: I think maybe three words to sum up the panel could be opportunities, stimulus as well as unprecedented based on our conversation today. Well, thank you so much for joining us, everyone. Really great to have you. And thank you for watching this Market Volatility Masterclass. I was joined by Tom Wald, Chief Investment Officer at Transamerica Asset Management; Malcolm Polley, President and Chief Investment Officer at Stewart Capital; and Tracie McMillion, Head of Global Asset Allocation Strategy at Wells Fargo Investment Institute. And I'm Jenna Dagenhart with Asset TV.