Long-Term Capital Market Assumptions: COVID-19 – New cycle, new starting point
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Kate Hurley: Hello everyone and welcome. I hope you're all healthy and doing well. Thank you so much for taking the time to join us today. My name is Kate Hurley and I'm a Client Advisor in our North America Institutional business here at JPMorgan Asset Management. I'm pleased to introduce my colleague John Bilton Head of Global Multi-Asset Strategy for the Multi-Asset Solutions Team. Over the next 60 minutes or so we'll have a discussion about the recent update to our long term capital market assumptions in response to current market volatility onset by COVID-19. So John thanks so much for joining us today.
I find it so interesting that this is the first time in nearly a quarter-century of producing our long term capital market assumptions that we have elected to provide an update outside of our normal annual publication cycle. Can you speak to this and what were the key findings as a result of the changes?
John Bilton: Yes. Thanks Kate and thanks everyone whose joined in. Kate you're right we've been doing this for 25 years now and it's my privilege to do the (chair) of (the thing) that puts it together. And this is the first time we've ever elected to do a cycle update for our members and we did it for a couple of reasons. First and foremost because we now have the technological set up to enable us to do it. We update these numbers once a year for 216 asset classes in 16 different currencies with a full workup across all of the major economic blocks around the globe and it forms the fact findings to be strategic asset allocations framework we use within the solutions business.
And the reason why it's so important for (us to look) to do a mark to market at the moment is because it has been such a significant move and with the technology framework we've built to support this program now we are able to update for the major currencies so the US dollars the Euros and we've also done Sterling across a number of frequently traded markets. The reason for doing this is (unintelligible) I think it's the first time (mercifully) in more than ten years that we've actually seen a turn in the business cycle and as a result having a program where we're able to check in offer a significant market move is incredibly important.
Secondly however it's worth noting that one of the issues that follows the asset market to 2008 2009 crisis is that the markets collectively investors, analysts, economists alike all made the mistake of confronting cyclical issues in structural issues. And one of the reasons for doing this remark is to understand whether some of the issues that are a problem today and of course equity markets perform (unintelligible) they drop to (hysteric) lows is something that will be permanent or otherwise. And but your take away from this is as we're entering markets today potential lower level and then obviously the US is rarely back quite some ways has given up some of those potential forward gains other markets globally you're entering at a lower price point.
Now crucially we do believe that although this will be a deep recession it won't be a lengthy one and as a result we would argue that a lot of these economic positivity that we've had through the last cycle will be renewed in time and as a result being able to buy that forward curve with growth in equity markets at a better price point means higher forward returns. The more bearish you are today the more bullish perhaps you should be about long term returns. The bear markets however one thing we are very aware of is that monetary policy at a very easy levels is likely to be with us for many, many years to come.
With starting yields now well below zero in real terms and in deed in nominal terms in many countries such as Japan and Germany it means the outlook for the bear markets has actually been really pretty damaged. And as a result one of the biggest challenges we may face in the next three five ten years will be recognizing how we build portfolios to capture the gains on our free equity markets and other alternatives that spread through resilience into our portfolios in the bear markets returns are now so challenged.
Kate Hurley: And John how about the macro outlook has that changed as a result of the crisis?
John Bilton: Well I mean (unintelligible) exercise we haven't upgraded our macro assumptions to be current and this is good rationale for that. We think such environment (unintelligible) market and this is important to actually think about once that price moves up. But what (unintelligible) doing this exercise is that it highlights an area of where we could get in difference in the macro outlets. So it's probably the way we think about things first and foremost. We think our view of the macro environment are something about how many people do we have and have it got worse and what's our labor population. We don't have the sufficient tools to do their jobs do they know how to use them and have they got a good process.
And then (unintelligible) have got (unintelligible) components and productivity capital gains (unintelligible) labor skills and total (unintelligible) productivity. And then finally on top of that we put an assumption around how policy frameworks will work with regards to inflation. When I put it all back together they'll already (unintelligible) of being really hurtful on human levels. It hasn't mean (unintelligible) for our labor market assumptions over the long haul and we also would argue that in some cases the presence of fiscal stimulus is likely what's set in capital spending some of the productivity gains if (unintelligible) is being lost due to (unintelligible). So we'll (unintelligible) our major (theme) is loss to the economy and not much changed from a real world perspective.
(Unintelligible) comes to (unintelligible) and monetary policy acting in unison. In the last cycle we had (unintelligible) with (unintelligible) and a lot about coming back fiscal deficits and dealing with debt (lows). And that's clearly going to be something we have to tackle in the years to come but the one thing that will separate the next cycle from the one that preceded it will be the fact that we have fiscal and monetary stimulus operating together.
We believe that over the fullness of time that means (unintelligible) for more inflationary environment greater demand for our stimulus higher debt levels for certain relative to GDP but at levels of interest rates which means that there is some (scope) that we will have to think about for natural repression over the intermediate terms particularly with regards to stocks and bonds.
(Unintelligible) the curves could well mean an environment where we get more of a focus back on how those fiscal dollars get spent with the winners and losers being defined by how well fiscal dollars are deployed towards production and investments as opposed to fixed assets or single tax cuts.
Kate Hurley: Great insight. So I think we could all use some positivity these days. At what (unintelligible) do you elaborate on what areas you're now seeing more future value? Could you detail those for us?
John Bilton: Sure and you're right about positivity and this is a really important thing. There are ultimately although we are in a phrase of a deep crisis and although we've seen this translates not only to health crisis but also a human crisis on multiple levels we should also recognize that out of bear markets as the price (leads) are built and new bull markets in the new expansions. And while we should I think be (circumspect) about, you know, (some) you see today in recognize that we'd like to have (unintelligible) volatility for the time yet. I think that the point to remember is that when we look forward we are constantly surprised by the level of ingenuity and innovation that we see coming through in times like this.
One of the things I think that we've seen from this crisis has been the fact that we've seen a massive acceleration in technology adoption something that we would argue over the fullness of time should be able to translate to productivity. As I mentioned a moment ago the fact that we've now got fiscal spending one of the things we've lacked in many parts of the world was a pick up in productivity and that adjusting (unintelligible) the capital investments. The capital investment started in the (unintelligible) world in essence (follow-on) from getting stirred on by government spending.
And so ultimately the notion of (crowding) out it doesn't really necessarily follow through in most economies but as a result having that spend in that investment providing (unintelligible) is the reason for positivity. So (let me look forward) and (another thing we) would argue is just again is that single thing. If we don't believe that over a long term potential growth is being returned and that we've certainly done then if you are able to buy back forward curve with great truth of the day your return will be higher tomorrow. And so all else equal while there are some things to watch for areas (not shared) international equities it continues to look as if they could have an opportunity to go capture in the next cycle.
The more inflation we (unintelligible) the greatest cyclicals involvement (unintelligible) are focused on areas of technology structures renewable energy, et cetera actually lends itself to broadening out that they have a value through innovation around the globe. Another area of course if emerging markets already coming into this crisis having been impaired in valuation terms (unintelligible) being traded (unintelligible) before. And so now we've seen an emerging market equities for instance on a price to built this $1.3 to $1.35 depending on how you slice the (unintelligible). That an entry-level which historically it's been very compelling.
Also areas such as alternatives came from private equity especially in a world with a little bit more differentiation a world with a bit more volatility we would argue that the ability to (unintelligible) to be turned into natural (unintelligible) returns is all else equal higher. And so we would argue that coming into this crisis we heard a lot about private equity in the (unintelligible) and having cash on the books that (unintelligible) value returns. That cash on the books now looks (unintelligible) (power) to be deployed in terms of picking up assets and industries which are very (unintelligible) structural change. And yes there will be turmoil and disruption in some industries we wasted new opportunities to merge and being able to buy into that.
Being able to looked at how the future will mold the way we work the way we travel the way we operate generally that's going to be something which I think will be future exciting of the investment opportunities. So in days like these are very difficult to look at markets and look at the news (unintelligible) and say it's highly positively certainly when we look forward we think about the elevation that we're unleashing today that's something which I think we should (unintelligible) to and think about for the longer term.
Kate Hurley: Excellent love to hear the positivity. So (what's) the alternatives? It looks like US for real estate has also been marked up and, you know, this crisis has really brought real estate to the forefront with so many of us working from home. The question is will we even need offices anymore and will retailers need as many if any locations? So what's your outlook on real estate?
John Bilton: Well I can assure you (unintelligible) in my office at home at the moment with my wife and children actually is probably best (unintelligible) back to the office. So I would imagine that the demand for offices is probably still - it's not going to go to zero let's put it that way. But clearly we're going through a transition and it's really important to think about this. So I was on a call with (Unintelligible)who runs our alternative (unintelligible) a couple of weeks ago and I was struck by one of the comments she made which is some of the impairments which have been seen across real estate are no different really (in crisis of the past). But I liked crisis of the past where it's been because of excessive leverage marking down asset values.
This is simply recognized (in the middle) of recession there will be a period where it's going to be a lower level of rent collections. But there's already a decent (unintelligible) against for instance triple B spreads built into a lot of the real estate business. More importantly the assets themselves are under leverage. So if you look at real estate in that simple macro lens actually can see resilience there. One of the reasons we've marked up core real estate is reflecting a little bit of a (unintelligible) in terms of entry points means that we're effectively pushing forward in some of the returns because we're entering a slightly impaired level to reflect some of the near term issues.
But then I'd actually look at it a little differently because (unintelligible) fiscal assets we need to act with the world around us and (unintelligible) we've been interacting in shopping malls and (unintelligible) in (unintelligible) and offices. We may do less of that in the short run. We may do less of it permanently but for every person who's working from home because (unintelligible) what they will need is infrastructure. What they need is cell phone towers. What they will need is data storage centers and this will all be remote (unintelligible). And also for every person has given up on turning out at the shopping malls to buy their goods and dine instead remotely they're relying on logistics help transportation networks.
So real estate is a real asset for food and (unintelligible) has not gone away but looks of them may well be changing and rather interestingly I think the (unintelligible) that these types of assets have towards the technological revolution and towards intervention is sometimes underappreciated and then for that because I think it makes what (unintelligible) is rather sleepy asset class actually incredibly exciting to look at.
Kate Hurley: So and perhaps the not so positive side you mentioned higher debt level. So let's talk about debt for a minute. You know, with governments and corporations they'll undoubtedly have higher debt coming out of this what does this mean for long term?
John Bilton: Yes. So, you know, (unintelligible) this is the bit that's going to be hard to navigate but it's not the first time in our history that we've had to deal with debt. And certainly if you look back at the experience in asset markets in the 50s and the 60s that's something which happened. It's a situation where I think again you got to come back to simple finance 101. If you're looking at (something) which is delivering you a return which is below the level of nominal growth then that asset is going to be shrinking its attractiveness over time. I mean (the analysis) is what you'll see is (unintelligible) out of the way simple mechanics and that's the world we see.
One of the big findings for us from the (unintelligible) and has long term capital markets (such as) remark and again if you look across the (unintelligible) bond markets so US dollars Euros Pound Sterling and Japanese Yen and then no part of any curve with the exception of the (unintelligible) (very sure thing) in the US when the need to return will outpost on an average annualized basis our expectations of inflation. Well that means anywhere effectively accepting (unintelligible) real return in the bond markets. Now to be clear bond markets and job (unintelligible) will operate with a negative correlation in the equity markets and do portfolios (unintelligible) but the interesting thing is (unintelligible) insurance products for portfolios effective in what they do is they provide you a degree of (unintelligible) or they offset cash flow.
They've got to be used in the way that you (unintelligible). If you're using them to match cash flows they'll still work by and large. If you're using them to (unintelligible) the portfolio the negative correlation will still work by and large. But unlike previously you're now paying for that insurance just in many, many years, you know, one insurance policy depends (really) to have it. So the crucial thing that we think about it is that in the (unintelligible) debt level (unintelligible) higher leverage on corporations that possibly means corporations having to (unintelligible) more (unintelligible) in terms of how they manage their portfolio. If we use the companies operating with higher levels of leverage means the balance sheet and this is a bit more pressure in terms of (unintelligible) of platforms like their asset (unintelligible).
And it brings about being able to run their supply chains internally more efficiently. At the governmental level we would argue that the biggest differentiator will be (unintelligible) because of course when you deal with debt to GDP you can either tackle the denominator or the numerator and in the prior expansions we mostly tackled the numerator the debt side of it by trying to bring it down. Clearly that time is gone.
So what we now need to do we need to (unintelligible) down by cyclical authorities and if the money being spent by governments it needs to be put to work in productive assets. It can be done it (unintelligible) successful in comparing contrast between seeing how the periphery of the second Euro is spent in (unintelligible) of lower interest rates as they joined the Euro back in the early 90s compared to have Germany reunify to use that investment to build (unintelligible) the big powerhouse of the German economy demonstrate. So there are two ways to spend these fiscal dollars. Spend it the right way and we would argue that (unintelligible) the denominator it will be possible to deal with this debt rate over time but not every country is going to be successful in doing this.
Kate Hurley: And as a follow-on I mean can you see any interest rates going any lower?
John Bilton: Well I mean yes we have to accept the fact that interest rates (unintelligible) there isn't a zero (level now) but we would argue quite strongly we think it is unlikely that the US will take interest rates even (unintelligible) has been quite (unintelligible) from that idea. So I think the reasons for that by and large is because we've seen the damage that it's done to the (unintelligible) of the banking system within the Eurozone and some of the (unintelligible) had to be brought in to places like Japan (unintelligible), et cetera where significant situations like clearing had to be brought in. This effectively (unintelligible) the impact and monetary policy transmission.
And so all else fiscal we would think that it's more likely with interest rates that where they will fall because it's where there's still a little bit of room and that will be mostly in emerging markets where the different inflationary impulsive (unintelligible) refreshing that we face gives them a bit of room to do that not potentially is supported there. But then we would think that monetary policy (unintelligible) would be much into forward guidance. And so certainly our expectations when we come to thinking about the assumptions for the next (unintelligible) will be seeing normalization (paths) and interest rates pushed out probably some way because we don't believe that we're going to see a time any time (particularly soon) when central banks were able to raise rates.
And the next policy tools may well be the communications of that as opposed to actually moving the rates themselves.
Kate Hurley: So switching gears here a bit there's an argument that the pandemic adds momentum to the trend of deglobalization. What's your thoughts on this? And then someone suggested once an economy has become less (unintelligible) is this likely to be a long term inflation driver as really labor and production costs are likely to be higher in this scenario?
John Bilton: So there's a lot that talk about deglobalization at the moment but I know my personal colors to the (unintelligible) I'm not a believer in deglobalization and part of that comes from the data. So if you look at where we went from the, you know, late '80s until present day from the late 80's early 90s and until around about the middle 10s we saw global (unintelligible) in nominal terms outsourcing nominal GDP on a global level were roughly 2 to 1. And over the 2010 that declines back to the two growing roughly in parallel with one another. The global (unintelligible) maybe roughly at the same pace.
And over the long haul I've seen little reason why that would change. We've gained an awful lot I think in terms of supply chains from globalization but what's happened clearly is the whole notion of running supply chains on a very very (unintelligible) basis and adjusting time basis I think is something which has been challenged by this crisis. And it’s (unsuring) production may happen at the margin in certain key industries. It may mean that companies in the near term run slightly (unintelligible). But what's more likely to happen I would argue is just the reliance on single points of offshore production potentially what we distributed out.
So one element in the supply chain did not become physical and that's already started to happen following the (unintelligible) between China and the US over 2018 and 2019 we already saw a lot of production shifted and (unintelligible) would be much more widely around Southeast Asia. And also within the Eurozone we've seen some of the German supply chain shift a lot across (unintelligible) of the block. And certainly sending back supply chain perhaps (unintelligible) more widely across the globe is the more likely outcome.
I don't see another big surge in globalization of the (unintelligible) market but certainly continuing to grow roughly in line with nominal GDP would seem sensible whereas (unintelligible) globalization will start to pick up however is in the globalization of services and labor. One of the things that we have to accept is having seen how quickly and smoothly and it's a surprise to many of us myself personally and how quickly many industries have been able to adapt to (unintelligible) working in the services industry suggests that the globalization could come will be in the laboring sector and in the services industries.
And that potentially creates something of a (unintelligible) inflation of pressure half the margin but remember it's likely to still be dominated by the much growth of dominance of cyclical stimulus which in and of itself is a big driver of reflation.
Kate Hurley: It makes a lot of sense. So as part of the remark assumption you collected perspectives from various JPMorgan experts on their experiences during the past (unintelligible) of the economy markets it's probably my favorite part of the paper but can you tell us your perspective on how the correct prices compare?
John Bilton: Yes so I'm hugely grateful to my colleagues around the business and I think some of the things which have really struck me and (unintelligible) you (unintelligible) (on this call) so I will repeat some of these (unintelligible). At the end of the day recessions the market crisis have an element of learning by doing everyone is unique every single one. Everyone has a different flavor to it but there is certain (unintelligible) and certain (cadences) which repeat. And I think there is one thing that we can identify that with crisis is just it moves much more quickly but many elements of it has got shades of what happened in the past.
The exact (and objection) is liquidity is one of the things that I think that really shrunk down is duration of (this crisis) and (unintelligible) the deviation that we see talked about between Wall Street and Main Street. But as I look through it and I think about, you know, I worked with (Unintelligible) he's the CIO of the solutions business and he's been in the market for over 40 years and he's on record as saying he's never seen anything like it. But there's some other things which I think (really excite me) and one of the things that I (Unintelligible) head of equities in the US when I read her comments and it really struck me and (unintelligible) stocks are worth their future cash flow they've made (unintelligible).
It's incredibly important when thinking about it long term and one of the (unintelligible) to gain positive at the moment over the longer term is just while we're looking at a period of volatility today the future levels of growth the future cash flows are still reasonably resilient in our view. If we can (buy those) a little bit more (cheaper) than potentially we should be a little bit more optimistic in the longer term. And certainly if we see the analysts now by and large and really mark down aggressively their quarter two earnings expectations we're getting to the point and thinking about well where do we go from here and the curve is beginning to slope upwards.
And then of course another person who many of you will know who I've worked with very, very closely (Ted) (Unintelligible) we've recollected on his experiences in the crisis of 2007 2008. And just as you're seeing question marks coming back up about whether we are seeing a resurgence in to a political rhetoric between China and the US issues developed in certain aspects of relationships that China has with other trading partners such as Australia he makes the point that there's always more than one thing going on.
And this is something which I think is important for people to recognize today we see (unintelligible) which is focused on the crisis but the market is still going to have to come through and calibrate everything from earnings to trade for the US selection to some of the new packages announced within the Euro zone. So (unintelligible) changes in the way our (unintelligible) is operating.
And all of these things the market will have to calibrate through time and that's one of the reasons why today although I'm optimistic for the future I really get more near term volatility really wouldn't surprise me but certainly will give it the opportunity to lean into some of those views that we like to add to market (unintelligible) motions in the weeks months and quarters to come.
Kate Hurley: Really great points thanks John. So let me enter the future, you know, let's say considering a five year time horizon would you say that this is a good time to re-risk or is another significant drop expected?
John Bilton: Well I mean the one thing that you can say with certainty at the moment is that there are (unintelligible) so (unintelligible) a reason to change (unintelligible) more (unintelligible). And the reason for that is you know what there (unintelligible) for the top (unintelligible) and more rapid return to work. So rapid (unintelligible) the lockdown and potentially (unintelligible) we've seen from the (price) action of recent data that the market is quite mobile in both directions.
And so for a long term invested (that should reinforce the fact that) what we should be looking to do is to make sure that we go back to thinking about solving our primary investment objectives and that will tell you whether it's time to come into the market or not. If you're looking to generate certain level of return from a certain balance of assets and you're able to do that today that goes a long way to answer whether this is the time to invest or not. Second guessing don't trade ineffectively from one day to the next day over a market level.
I think devalue those long term frameworks that we as investors should be looking to do. Now above all else we should be disciplined about how we put that money to work. We are somewhat optimistic because when we're looking to the longer term we're applying our framework. We think we can buy a balance and (unintelligible) and markets we can buy a balance of alternative assets and real estate at levels which we see are more attractive much closer to the secular return at delivery and over the longer run. Across that means that it does look (as an interesting part) in becoming (unintelligible) like volatility today is higher (unintelligible) around about the (unintelligible) levels.
Typically for the second half of the expansion the (unintelligible) is averaging below 20. So we see the higher volatility (time) and actually kind of (unintelligible). Number one for each and every term you want to buy you are committing more risk budget for (unintelligible) and opposition appropriately is key. And number two if we are trying to add (unintelligible) of the timing and move volatile markets may (unintelligible) some opportunity to enter. But if that's the way one is choosing to (unintelligible) into the markets it's very clear to know what your objective is and what your entry points will be and be sure to execute from them once the market gives you that opportunity.
But by and large we still think that the usual (unintelligible) of investing (unintelligible) which is think about your portfolio objectives think about the verifications if you return objectives can be met then putting the money to work genuinely you're doing the right thing today.
Kate Hurley: Thank you a great reminder. And John I have one more question for you. How much...
John Bilton: (Yes).
Kate Hurley: ...oil? What other outlooks or oil companies and the oil price?
John Bilton: Wow, you know, I think it's an interesting one all around. I think what we've been getting (unintelligible) of oil and the fact that at the end of the day the suppliers (unintelligible) is sometimes not the (unintelligible) that it needs to be. I think on the good news side of things and I think the (unintelligible) trying to (unintelligible) we're beginning to seeing the country emerge from lockdown develop the manufacturing data starting to pick back up again. And then actually oil demand has picked up quite some way. It's getting close to its (unintelligible) levels but across levels, you know, (unintelligible) which is still only just emerging from lockdown that oil demand is still going to be blunted.
And then particularly with air travel having been pushed down that again is a short term overhang for demand for oil. Now over the intermediate term I mean we do think we'll see something in the supply (unintelligible). Certainly it's interesting to note that conventional oil tends to have roughly a five year investment cycle and if you give it back (unintelligible) it's a little bit of a hit for that kind of well. So some of the forward supply of oil may be a little bit more impaired in our view and certainly when we look over the impact from the (unintelligible) which again it's suggesting that a bit more supply (unintelligible) and that is coming through from (unintelligible).
But it doesn't take away from the fact that we can (unintelligible) a longer-term demand for will the (unintelligible). We think that some of the systems (unintelligible) being said today, particularly in places like Japan and the Euro Zone which are not energy independent and more (unintelligible) through conventional or (unintelligible) terms. We would argue that the emphasis there to think about energy efficiency, clean energy, renewables, etc., will be something that is very much aligned to the fiscal spending which we think those countries will do. And that potentially has the capacity to (unintelligible) in the longer term.
So for the time being, certainly we've seen some recovery in (PI) and some recovery in (unintelligible) come in which is obviously the summer coming up on us but specifically, will sort of boost the demand (unintelligible) demand through air conditioning and gradual uplift in travel. But we certainly do not expect to see anything much above the (unintelligible) $40 to $50 per barrel level (unintelligible) unless we saw significant supply disruption. But one of the reasons why you think that we will be (unintelligible) towards that level is that (unintelligible) that level that you have the kind of (unintelligible) in many of the OPEC nations.
And that's really important point to watch. So while we can get (unintelligible) the very short run, certainly the emphasis to allow oil to be at a depressed level for prolonged periods is just not there for OPEC nations. So oil in the near term could have some level of recovery and some level of support as we see demand coming back in. Longer term don't underestimate the importance of (thrifty) spending and that renewability agenda in parts of the world like Asia and like Europe and the effect that that could have on the demand on the ten-year horizon.
Kate Hurley: Thanks, (John). We hope today's call was impactful for you and thank you all for your partnership. If you need any additional information on anything that was discussed, please reach out to your JPMorgan client advisor. We're all here to help. So again, thank you all for participating today and thank you, (John). Stay well, everyone.
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