The Economic Outlook for 2020

BRYLSKI: Thank you, everyone. Welcome to our CFR conference call.

We are so pleased to have Wells Fargo’s Darrell Cronk and BNY Mellon’s Leo Grohowski joining us today. We’re going to be chatting about what we are thinking and what our outlook is as it relates to the growth expectations for this year and the geopolitical events that could shape this year’s economic outlook.

As a reminder, my name is Pamela Brylski and I will be moderating the call. I just want to also remind everyone that this call is on the record.

So let’s get started. Given where we are this week, I think the first question is probably obvious to all. Want to talk a little bit about the coronavirus and just get your thoughts, both Leo and Darrell, on what is going on in the global market. And given the coronavirus, can you give us your thoughts on how this will potentially impact the economic cycle both globally and domestically? Leo, why don’t we get started with you.

GROHOWSKI: OK, Pamela. Thank you very much, and thanks for having me on the call today.

I’m really surprised you made that the first question. (Laughter.) Totally kidding about—totally kidding about that.

You know, the timing for the call is actually outstanding, and it’s really remarkable to me, you know, the extent to which the coronavirus has, you know, reintroduced volatility to asset markets almost on a lagged basis. I think it was only, you know, a week to ten days ago I was, you know, reading reports about really putting that wildcard aside. Well, that wildcard, you know, has really become the big question mark. And I think as we all know, you know, markets don’t like uncertainty. And I think, you know, the severity and longevity, and the uncertainty around that, does lead to, you know, uncertainty when it comes to things like earnings and GDP estimates.

Our best guess at this point is that the virus will likely take about a ½ to 1 percent out of first-half GDP globally and one(-tenth) to two-tenths (percent) out of GDP in the U.S. But if you were to ask a follow-up question on my confidence level, obviously, it’s low because of the—because of the uncertainty. I would say that as governments take what we would consider to be outsized precautions, that could lead to a more significant slowdown in the shorter term, but it could also improve the likelihood that the slowdown is more transitory in nature and that we do get a more V-shaped recovery around the—around the world, that demand is rather postponed instead of being destroyed.

So our view right now is, clearly, we’re right in the thick of it. Uncertainly is very high. We do think this is going to have an impact on global growth, but we are in the camp of not believing this is going to tip us into a recession. If we had to attach a probability to that in the U.S., it would be around 20 percent over the next twelve months. So we still think the probability of recession is rather low, with the consumer representing a very, very important backstop here for the United States against a recession.

BRYLSKI: Thank you, Leo, for that.

Darrell, can you give us your thoughts on the coronavirus and its impact?

CRONK: Sure. So good morning/good afternoon, everyone. Thanks for the opportunity to join.

I think Leo did a nice job of summarizing it. I would just add maybe a few points.

You know, it’s interesting that growth was picking up in the fourth quarter prior to the outbreak in January of the coronavirus. We were seeing some green shoot signs in the manufacturing sector, which was largely in almost a recessionary environment for much of 2019, and that’s probably going to change—to Leo’s point—in the first-half data. We actually tend to think first-quarter data, both emanating from China as well as probably a good chunk of the Western—continent of Europe and the U.S., less so the U.S.—but the global data will be pretty bad, nothing short of perhaps even terrible on that initial shock, and then some payback.

The real question is, is it a V-shaped payback or is it a U-shaped payback? I think a couple weeks ago the markets were anticipating more of a V-shape recovery to it and that the virus would be contained largely in China. That data and information has changed, and I think markets are repricing more of a U-shape or elongated recovery, which really puts a question mark about 2020 global growth estimates. If it is an elongated U then it probably is going to dent global GDP decently this year, and that’s starting to evolve as more of the base case.

Just a couple of other quick points on it. A lot of people used the SARS—2003 SARS comparison, or maybe the MERS comparison, or the avian or swine flu. We think it’s a little bit different. I mean, if you go back to SARS in 2003, China was only 4 percent of global GDP growth. Today they’re 16 percent, so they’re 4X size in comparison. SARS was largely contained in Asia; coronavirus is not looking like that is going to be the case at the end of the day. And coronavirus has a much quicker uptake with a—with a lower mortality rate, but a much faster uptake of people becoming infected than SARS ever did.

The good news—you know, what we’d be watching for the markets for good news is, one is if you can get a medical company to suggest they think they’ve got a breakthrough on a cure. Two is if there is evidence that coronavirus is being contained largely in places like China and Italy, which is absent today. Or three, if the CDC or the WHO does declare a pandemic and the U.S. has a strong action to kind of control contagion, I think markets would react favorably to that. Leo’s good point about that strong reaction to contain the virus also has downstream economic impacts as well.

So there’s a lot to talk about there, Pamela, but I’ll pass it back to you because I know we’ve got a bunch of topics to cover.

BRYLSKI: No, no, thank you, Darrell. Thank you both for your perceptions on that.

So given the obvious risk of the coronavirus, Darrell, why don’t you let us—let us understand your insights on what other risks that we should be aware of for the rest of the year, as well as what are some of the other major opportunities we can look forward to?

CRONK: Yeah. So I think everyone probably, likely, on this call knows—and Leo and I can have a long conversation about—this is the longest economic recovery on record. We’re into the eleventh year. Interestingly, or maybe not surprisingly, it’s the slowest and shallowest economic recovery in cumulative GDP growth for the U.S. on record as well, or at least since post-1950. So some of your bulls that would argue that this expansion will continue will make that case, that you’ve only had a little over half of the cumulative GDP growth during this expansion cycle, even though it’s the longest in years, that we’ve enjoyed in other economic recessions, therefore more growth still lies before us.

We don’t see, albeit it’s a vexing conversation, a 2020 recession right now as our base case. But that can change depending on particularly the pandemic issue. You know, the big issues probably that markets are going to face are things like the pandemic, certainly elections. The consumer—to Leo’s earlier point—needs to stay strong, so we need to see consumer confidence and consumer spending remain high. And we need to watch business confidence, as well.

I would just say, you know, when you think about recovery cycles and recessions—because I often get asked the question about, you know, when does the next recession cometh and what will cause it—it’s very difficult to know or tell. But if you were to use history as a guide, recessions typically come from three areas.

One is some kind of a central bank policy mistake, meaning particularly the Fed or a global central bank overtightens conditions. Doesn’t really seem to be the case today. They’ve been on an easing path and look to continue to be on an easing path.

Two is you typically get some kind of a(n) unexpected spike in inflation—not high levels of absolute inflation, but just a spike in inflation. Again, not our problem; if anything, we’re begging for more inflation not less inflation given the anemic nature of the cycle.

And then three, which may be the most obvious one, is I guess what I would call for lack of a better term is a bolt from the blue, right, which is an unforeseen kind of shock or economic event. So think things like 9/11, the oil embargo back to the ’70s. And you’d have to put, you know, pandemic—global pandemic—on that list, so that one might rise to one of the reasons the cycle could end. Again, still not our base case, but I think important things to think about.

BRYLSKI: Perfect, thank you.

Why don’t we talk a little bit about the U.S. market. So, Leo, you both have given us a great framework for the—for the global and domestic economic outlook. Can you share your thoughts on—given the performance of the U.S. stock market last year, can you provide your thoughts on if we can really sustain the upwards movement that we’ve seen?

GROHOWSKI: Yeah, Pamela. I think, you know, first point, maybe following up on Darrell’s last comment, that you know, global growth slowdowns don’t usually portend recessions in the—in the U.S. So part of the reason why we’ve got a pretty low probability there is when you look back to, you know, 1975, ’82, ’91, even ’09, right, it was really more the U.S. led. So that’s why we’ve got our eye really on the impact here in the U.S. and the consumer.

I think with respect to the—with respect to the U.S. equity market, you know, last year was, you know, truly a remarkable year: a 31-plus percent return total out of the S&P with dividends reinvested. I find—found myself, you know, ending the year and starting this one just, you know, reminding investors about how not only rewarding it was from a—from a return standpoint, but how remarkably low volatility was. Whether you look at the VIX or even the fact that we hadn’t a 1 percent move up or down in the market close from October 15 through the end of January, January 27, absolutely remarkable. So you know, let’s kind of let this be a reminder that, you know, it’s very difficult, to Darrell’s point, you know, predicting what’s going to cause, you know, drawdowns and pullbacks and potential corrections. But when we do have periods of, you know, low risk—and I’m sure we’ll get back to one—where complacency is too high, we should use that as an opportunity to—you know, to diversify and potentially hedge.

I think the backdrop for the U.S. equity market continues to be what I would call equity friendly. I think we still think we’re going to look at 2 percent GDP growth. Our earnings estimates will need to come down, but really consensus will probably come down closer to where we are today, maybe 1.70 on the S&P. And so the challenge we have is, you know, valuations look very, very full. It’s really hard to say that we’re in for another 20 or 30 percent year with full valuations. But I would say, you know, the markets remain pretty friendly. Valuation’s certainly not relative to fixed income, given—with ten-year Treasury yields down at a 1.33 level as we speak. You know, valuations look compelling on that basis, but we do have to be careful of these snapshot valuation reads based on, again, flights to quality into the fixed-income markets, and we’re seeing some of that today.

So we continue to believe that we’ll end the year at sort of a 3,3(00) to 3,400 level on the S&P, and that will basically mean the U.S. equity market tracking an earnings increase of probably mid-single digits. I think consensus up until two weeks ago was looking at maybe mid-to-high single digits. We think that’ll have to come down. But I think the market’s going to track earnings. And as long as, you know, we get through this and earnings can grow sort of at 5 percent, that’s kind of what we’re looking at for the market. I wish it can be more robust than that, but I think we had a lot of multiple expansion last year as the Fed pivoted and not a lot of earnings. So I think, you know, valuations are looking to us to be pretty full.

BRYLSKI: Thank you. Thank you, Leo, for that.

So just talking a little bit about the Fed and the other central banks—Darrell, maybe you can give us your thoughts on this—they, obviously, had a lot of influence in what happened last year, especially with the U.S. stock market. Can you give us your thoughts on where you think the Fed is going to be and the other central banks this year, especially given the level that we’re currently at?

CRONK: Sure, and Leo did a great job of summarizing. Just to accentuate his last point about—on the equity market before I switch to the Fed, we went back and ran the numbers. Everybody knows the S&P was up 31 percent last year; 92 percent of that 31 percent came from multiple expansion, which means only about 6, 7 percent of it came from earnings growth, right, which we know that is not the right way you want to get returns out of the market. So we need to see that flip this year. We think it will. But it’s important because we stepped off into this year at probably the highest multiples we’ve been since 2003. So to Leo’s good point, the market isn’t cheap.

As it relates to the Fed, I mean, everybody knows last year the Fed pivoted, you know, and cut rates three times. They were, we believe, on the verge of making a policy mistake until they reversed course in 2019. And now, as we walked into this year, calendar year 2020, everybody thought the Fed was kind of on a sabbatical, right, and was basically going to be on the sidelines and do nothing for all 2020. That has changed even this week, given the coronavirus, and now fed funds futures are actually pricing in two Fed interest rate cuts in calendar year 2020 and one in 2021, so three cuts.

If you take fed funds today, it’s at 1.50 to 1.75 is the range. So if you think about going to a zero bound at six .25 rate cuts, I would suggest you use half of the ammunition they have in monetary policy in interest rate cuts. So we’ll see how the pandemic plays out, but certainly the bond market right now, with the short side of the yield curve inverted—the intermediate and long side is not—is kind of screaming for the Fed to cut rates and basically saying the Fed is too tight still, even notwithstanding the conditions.

Probably what gets a little less airtime is the Fed also, in October, embarked on what they call open-market operations, which was a purchasing of $60 billion a month of securities to try and help backstop the reserves and the repo market for the banking system. So at sixty billion (dollars) a month they’ve expanded the balance sheet pretty good already. They’re anticipated to stop doing that in June of this year. We’ll see. But those open-market—open-market operations are really important to keep kind of piping in the engine going for the banking and credit system. So whether they can stop that and not have any issues on the short side of the curve kind of remains to be seen.

So we do think the Fed probably is going to have to do something with rate cuts this year. And right now, I guess we’ll believe the Fed and take their—take them at face value that they’re going to stop doing the expansion of the balance—you know, purchases in June, but a lot of that depends on economic conditions and how bad coronavirus kind of dents GDP growth in the near term.

And just the last point I’d make there, too, is the Fed normally—I think most people know normally likes to stand on the sidelines during an election year, and they prefer not to make a lot of adjustments to rates or monetary policy. So we’ll see as those two kind of worlds collide and come together which one has to give.

So, Pamela, I’ll hand it back to you.

BRYLSKI: Thank you, Darrell.

Leo, do you have anything you want to add on that?

GROHOWSKI: You know, I think Darrell covered it really, really well. I think, you know, globally accommodative monetary policy I think will continue to function as a—you know, sort of a backstop. And I think short term we’re going to have to get through, you know, kind of a lot of rhetoric and market angst around, you know, where the market is pricing today—as Darrell well covered—in the form of futures and where the Fed is, which is—I think in speeches this week Vice Chairman Clarida and two weeks ago, you know, Chairman Powell really I think taking a balanced, pragmatic, slightly dovish approach, but obviously not, you know, ready to—you know, to pull the trigger; the market taking a shorter-term view. So I think in the near term, right, we could have some volatility, some concern, and maybe a lot of rhetoric, but I do think, you know, we do have the support of the Fed and global central banks.

I will say now, in case we don’t have the time, I get asked the question—I’m sure Darrell does a lot, too—you know, what do you lose sleep about at night. And there are really two things that—and they both do not relate to equity markets.

But you know, number one, liquidity, right? And Darrell sort of covered it, but a few months back we had a—you know, kind of a mismanagement of the balance sheet at the Federal Reserve overnight. We had repo rates go to 10 percent, just a little bit of a wakeup call there as to the importance of liquidity and sensitivity to overnight rates.

And as I look out on the yield curve, these globally accommodative monetary policies, you know, with still about $12 trillion of negative interest rates around the world, I’ve been at this for forty years and, you know, there are no textbook I grew up reading that said that with the U.S. unemployment rate at close to 3 ½ percent we’re going to pay you 1.33 percent to buy ten years’ worth of our sovereign debt, but if you go to Spain where the unemployment rate is closer to 15 percent this morning you’re going to get twenty-one basis points, right? So I do worry about this distorted yield structure that has been in place now for years, that we almost get too complacent and comfortable with it. And if and when, you know, the foreign central banks—the ECB, as an example, is, you know, finally able to take away some of that punchbowl, we can almost guarantee ourselves that the Spanish ten-year isn’t going to be trading at twenty basis points.

So I do think about liquidity and I do think about, you know, this accommodative monetary policy having distorted yield structure. And “distorted” is not a word that I like to have in the lexicon of, you know, investors.

BRYLSKI: Thank you, Leo.

So you guys have both touched on this in many of your answers, but the obvious is that we’re in an election year. And so, Leo, let’s start with you. I would—I would like to get your thoughts about how you think that’s going to affect the economic outlook. And do you think the market has priced in the risk, if any? And is it a good time to think about hedging about any potential market reaction based on the election this year?

GROHOWSKI: Yeah. Thank you, Pamela.

I’m actually surprised at the number of inquiries I’ve had, you know, just in the last few days that, you know, correspond with, you know, the market drawdown that I associate if not 100 percent than probably 90 percent with coronavirus. I’ve been surprised at the number of inquiries I’ve received as to, you know, how much of that drawdown, you know, could be associated with the—with Bernie Sanders’ rise in the—in the polls. And you know, I think the impact at this stage in where we are in the election cycle on the overall market is, you know, rather low. I do think at the sector level it helps to explain, you know, shorter-term performance. I would certainly single out at this point the health-care sector, where, as the Sanders candidacy increases, you know, we do see that impact, you know, at the sector level, the health-care sector. But I think we’re just going to have to be prepared for a bumpy ride here, and I do think we’re going to have to work through different probabilities and scenarios.

But most of the work we’re doing at BNY Mellon is really at the sector level. I think it’s going to be very dangerous, you know—you know, here we are at the end of February for an election—it’s going to be very dangerous to make asset-allocation decisions, you know, based on the probabilities of different outcomes with respect to the presidency and Congress. So certainly something to watch, particularly, you know, sort of from the bottom-up point of view. But we’re certainly not counseling asset-allocation changes, but we do think it’s going to add to a much riskier, more volatile year than that which we experienced last year.

BRYLSKI: Thank you, Leo.

Darrell, do you have anything to add on that?

CRONK: Yeah. I think Leo covered it well.

I would just say we spend a lot of time looking at and doing hedging scenarios, and so a lot of people came into this latest downturn just this past week or so well-hedged, which was a good thing. But the volatility curves and the VIX futures curve have big kinks in them around March, which would be kind of Super Tuesday and 65 percent of the Democratic delegates decided by the end of March, so you know well where the path is going on that, and then also again in November kind of post-election, meaning those are rich areas to hedge right now and expensive areas given the uncertainty around outcomes.

I agree with Leo, I think a lot of—you know, the most acute sectors that are probably of concern—health care, he alluded to it. You know, on the win of Sanders in Nevada by a substantial margin on Saturday had the managed-care stocks getting pummeled earlier this week, so a lot of discussion around Medicare for All and that type of thing, which would be not good for the managed-care sector. So you see it in health care. It’s also inlaid in risk premiums in financial stock and technology stocks, about the desire to regulate the tech industry even greater.

And then maybe, Pamela, the last two things I’d just say is so I do think it’s important investors—we get this every time and I, like Leo, have done this for years, and people always have a lot of angst around election years, and they’re always concerned that election years and the uncertainty are going to create a negative return or a bad year. If you go all the way back to 1928 there’s been twenty-three election years. Only four of them have been negative, and those four were 1932, think Great Depression; 1940, think Nazi Germany invading Poland; 2000, think the tech bubble; and 2008, think the great financial crisis. So the point is there are other factors at work there beyond the elections. Historically, elections are actually positive years for markets. And in fact, if you track them, most years they trade sideways to about midyear and then they typically break, regardless of Democrat or Republican, and they break positive if there’s a belief the incumbent is going to win and they will usually break negative if there’s a belief that the non-incumbent wins.

So there are some things, I think, that people can ground themselves in history and facts that help around elections. But this one has—I think perhaps Leo would agree—a lot more binary-style outcomes than perhaps we’ve faced in the past, depending on how November goes.

BRYLSKI: Thank you, Darrell.

So I think we have time for one more question before we open the floor for questions. So, Darrell, I want to get your thoughts on corporate debt. At the end of last year the figures were showing that we were at $10 trillion of corporate debt in the United States, and you know, a lot of people have a lot of concern around that. So given that concern, can you share your thoughts on how that would affect outlook on the economy, stock market performance? What does that look like for an investor today?

CRONK: Well, I do think it’s important if you level set at—you know, you think about the big areas of the economy. You’ve got consumer, business, and government, right?

Consumer debt, different than it was in ’05-’06, is really—the consumer’s not highly leveraged. There’s not a big amount of debt there.

Corporates are, actually, leveraged. If you look at what we call leverage, we use what we call nonfinancial corporate business liabilities as a percent of nominal GDP, so you’re looking at it, how it grows over time. It is highly leveraged today. There’s a whole ‘nother discussion about what is the source of that leverage and where does it come from, but there’s kind of undeniable facts that there is leverage in the corporate system and it’s built fairly significantly over the last several years.

Outside of just the absolute levels of leverage, we tend to—right now we’re trying to get our clients and investors up in credit quality. We don’t think it’s a time to reach for below credit quality. There’s a lot of concerning things that we see in the down credit stack, what we call kind of high-yield, covenant-lite, low-collateral loans that are somewhat concerning. They look kind of late cycle to us in a lot of ways.

I would make just two other quick point here and then, certainly, if Leo has anything he wanted to add.

The low interest rates have propped up prices in this hunt for yield for quite some time. So I think Leo was talking about this earlier. We do see that as concerning. It does all come down to liquidity. As along as companies have access to liquidity, all is good, right? If that sentiment changes, then you start to have problems. And where we watch kind of the cracks in the ice perhaps most acutely is you’re seeing it in some of the energy companies, which are typically lower in credit quality. With oil being fifty (dollars) or sub-fifty (dollars) today, that’s put a lot of strain on balance sheets and concerns in that sector. And we also see it in retail, where there’s a lot of cracks in below credit quality.

So point is we think you should be up in quality right now. You should be cognizant that there is leverage on corporate balance sheets. And history teaches us when that leverage goes up, not too far in the distant future so does generally delinquencies and default rates. So I will leave it there, Pamela.

BRYLSKI: Thank you, Darrell.

GROHOWSKI: And hey, Pamela, if I can just—I know it’s 1:30 Eastern time, but you know, to Darrell’s point, I—we really have to counsel investors to be careful in reaching for not only yield, but return, right? As I look at the corporate market, and particularly the lower end of quality, I think Darrell’s advice is sound because you’re really not getting paid, you know, to take on a lot of that risk. I mean, high-yield spreads over the last ten years, right, were in a range of, you know, let’s round it to between nine hundred basis points at the high and three hundred basis point(s) as the tights. And we’re at just about—just over four hundred basis points today. So even, you know, coming off of some of this recent concern about recession and the equity market drawdown, spreads are still pretty narrow, right, relative to historical norms. In the high-grade market we’re about a hundred spread over Treasurys, and you know, we were as high as 230 over the last ten years.

So I think investors—not only individual but institutional investors’ thirst for yield has really compressed spreads. And as long as default rates remain low, as long as the probability of recession remain(s) low and liquidity remains high, to Darrell’s point, we’ll be OK. But I just think we all have to be careful not to reach for yield and return particularly after a ten-year period that was pretty rewarding for most financial markets. And we just competed our capital market assumption study that we do every year for the next seven to ten years and, you know, we don’t think returns for the next ten are going to be as good as they were in the last ten. And so I think it’s going to lead to some challenges, but you know, as investors are challenged for return and yield we just really caution not to reach too aggressively, particularly into those lower-quality areas where you’re not necessarily getting paid.

BRYLSKI: Darrell and Leo, thank you so much for your answers on those questions. I know we covered a lot of really great information.

I want to now open the floor for questions. Just a friendly reminder to everyone on the line: this call is on the record. Katie, if you could please give us the instructions for asking questions that would be great. Thank you.

OPERATOR: Thank you, ma’am. At this time we’ll open the floor for questions.

(Gives queuing instructions.)

BRYLSKI: So, Darrell and Leo, why don’t we just get started. I have another topic to talk about while we’re waiting for any questions to come through.

Part of this call is the outlook, obviously, of the economy, but we’re also looking forward to hearing your thoughts on any geopolitical hotspots. We’ve talked about China in the context of the coronavirus as well as GDP, but can you share your thoughts on any other geopolitical hotspots, Darrell, that we should be thinking about this year?

CRONK: Sure. I’ll be quick on this.

So I would break it down into two categories. One would be geopolitical hotspots, of which I’d probably illuminate three, well, besides China. Let me just shelve China. Besides China it would be probably North Korea, Iran, and Russia continue to be the geopolitical hotspots.

I think maybe more importantly, though, Pamela—or maybe not more importantly, but certainly as important—economic hotspots to us continue to be Latin America and the MENA—Middle East/North Africa—countries, with falling commodity prices. Those countries are historically commodity producers and commodity exports. They were coming into this not terribly in healthy economic states to begin with, and so the latest downshift of commodity prices is only going to weaken them economically fairly materially in our opinion.

So geopolitical hotspots, economic hotspots.

BRYLSKI: Thank you.

Katie, do we have any questions on the line?

OPERATOR: Yes, ma’am. We do have a question from Andrew Gundlach with Bleichroeder.

Q: Hi. Good afternoon. Thanks for the insights.

I was curious if you’ve seen in or noticed in this downdraft, as well as perhaps the fourth quarter of ’18, any changes in the correlations between assets in a risk-on and risk-off environment. You know, I’m thinking about the dollar, which seems to go up in risk-on and risk-off now for various reasons, I think having to do with, you know, thirteen million barrels being exported and no more petrodollars. And then the yen is behaving very differently, and obviously gold with the supply side story. And I’m just curious if you’re noticing any trends there such that risk-on and risk-off are being expressed in different ways than in the first, say, ten years of this up cycle. Thanks.

CRONK: Leo, you want to lead out on that?

GROHOWSKI: (Laughs.) Yes, that’s good. You know, it’s a—it’s a great question. I’ll try to be—I’ll try to be crisp.

I think—I think the use of, you know, factors in investing, particularly in large pools of capital and institutional pools of capital, are creating some of those differences in, you know, the way that markets are behaving and responding. And that’s—we’ve done some work—we’ve done some work on that. And so, again, you know, factor investing has just become much more—much more prevalent.

I do think you raise a really important point here. And I think shorter term, particularly for dollar-based U.S. investors, I think, you know, being prepared for, you know, a period of greater strength in the U.S. dollar is what we’re, you know, really talking about because, you know, again, you know, most of our investors, you know, here in the U.S. with liabilities in dollars are investing outside of the U.S. unhedged. And we do think that interest rate differentials, particularly if the Fed sort of is more balanced and pragmatic a bit, you know, will argue for a—you know, a stronger dollar here on the—on a shorter-term basis. So that’s a really good point since we really haven’t talked much about currencies.

CRONK: And I would just—oh, sorry. Go ahead, Leo. My apologies.

Q: So the yen is now a funding currency as opposed to a risk-off currency?

CRONK: I’ll jump in on that one. It’s Darrell.

So I don’t know that I’d say the yen has completely, you know, migrated from a risk-off currency to a funding currency. It has in the near term, I think, because of the stark downdraft in the Japanese economy, there’s more to do with the yen than, you know, it being a safe haven or a flight to quality in the near term. You know, and I think that’s been more of what you’ve seen with I’ll call it the last thirty, forty-five days’ reaction in dollar-yen than anything, in my opinion.

And I agree completely with Leo; both the interest rate differentials—he’s spot on on that—but also the growth differentials have been, you know, the continuing element of the cycle unbroken. Many have died a slow, painful death trying to predict the end of the strong dollar, right, and not been successful doing so because the U.S. has still been the strongest-growth economy on the planet and the dollar remains the reserve currency of the world.

Q: So where do you see it—last question: Where do you see it going? I mean, you see an eighty-cent euro and a—and a, I don’t know, 130 yen? I mean, is it—how do you see the ride from here, longer term? Because the trends are irreversible, right? You know, why should—why should it correct?

GROHOWSKI: Yeah, I’m not sure that they’re irreversible. But I would say to us, actually in the very near term we think the dollar looks a little exhausted here, so.

Now, I don’t know that I’d jump out and predict massive dollar deprecation or anything like that, right, or a big downswing in the dollar. But I’d just—I think it plateaus here for a while. And if it doesn’t, given weak economic growth and weak earnings growth, you’re going to start to have bobbles, right, because the dollar starts to really put a headwind into earnings growth, which then comes back into and feeds into economic growth, and it just won’t be sustainable if those—if those currencies continue uninterrupted in those directions.

Q: Got it. Interesting. Thank you.

BRYLSKI: Thank you for the question. Katie, do we have any other questions on the line?

OPERATOR: (Gives queuing instructions.)

BRYLSKI: So, Darrell, maybe you can talk a little bit about emerging-market economies. Could you provide us where your outlook on emerging-market economies would be for this year, kind of given everything else going on globally and domestically?

CRONK: Sure. I can—(laughs)—I often get accused of being a little too frank and too much of a realist, but I’ll just be blunt and say we don’t like them. We didn’t like them particularly coming into pre-coronavirus. We think growth is weak. You can make a case valuations are somewhat reasonable on a historic basis, but we just think they’re really challenged. So not only—you know, China’s still, probably unfairly so, categorized as an emerging market. We know the issues and ails of China upcoming. It’s spilling heavily into the south, south of China, so think Indonesia, Malaysia, Taiwan. They’re going to have a real hard time. And I tend to think they’re actually not going to just—they’re going to lose growth and consumption that may never be recovered, frankly, whether it’s in late 2020 or early 2021.

And then don’t forget—I alluded to this earlier—but the recent downshift in commodity prices, whether that’s agricultural commodities, industrial commodities, or oil and energy commodities, really hurts the Middle Eastern economies and hurts the Latin American economies as well, as big oil producers and exporters. So I think they’re challenged.

We underweight them about as far as we can be in portfolios right now. That’s been a great trade, you know, for much of the cycle. The U.S. over international, large over small, developed over EM has been—and growth over value—has been the consistent places to be. And we think that trend remains intact, at least for 2020, in what we can see, Pamela.

GROHOWSKI: And, Pamela, it’s Leo. I would—I would say this probably doesn’t make for good debate, right, if we were looking to set up a point-counterpoint type of debate. And if we were doing this in video and not just audio, you’d be, you know, seeing me nodding my head. But in our asset allocation, you know, we have been and remain underweight emerging markets in favor of large-cap U.S. Our overall equity exposure is neutral, but the one tilt we have in place now is in favor of U.S. large-cap at the expense of emerging markets for many of the reasons that Darrell just mentioned.

And look, it’s tempting, right? I, you know, can seldom recall a time where, you know, the multiple-point discount on emerging-market equities is, you know, as significant as it is today. But you know, even if you argue that there’s further in this economic cycle to go, this tends not to be the time, you know, to be overweight emerging markets. And when you combine that to our discussion—with our discussion on the dollar, we just continue to be underweight in the asset class.

So for those contrarian investors out there, maybe that’s a good—maybe that’s a good sign. But you know, large companies like BNY Mellon and Wells Fargo are thinking the same thing when it comes to emerging markets.

BRYLSKI: No, no, thank you both for that. That was very helpful.

Katie, do we have any other questions on the line?

OPERATOR: At this time, ma’am, I show no other questions in the queue.

BRYLSKI: So since we don’t have any other questions, first of all I’d like to thank our speakers, Darrell and Leo. Thank you so much for sharing your insights and your thoughts on this important topic. I know it’s on top of everyone’s mind. I have lots of clients calling me about this too. So really, really happy, and thank you so much for sharing your thoughts with me and everyone on the call.

And everyone who joined us, thank you so much for the time, and look forward to having everyone at the next conference call. Have a great rest of your day.

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