Emily Larsen – Today Mike Dowdall, investment strategist and portfolio manager at BMO, will share the themes and ideas he took away from this year’s Forum. As you heard from Mike at the top of the show, the Global Investment Forum report takes a step off the dance floor and onto the balcony to lay out a global investment thesis for the next three to five years. If you want to listen to a previous episode about the Forum, you can check out episodes 66, 42, and 17. Since the medium term predictions in those episodes apply to the present moment, you can still go back and listen to them to see how our batting average is faring. Last year’s theme was room to run and, according to Mike, that’s mostly played out.
Mike Dowdall – The U.S. economy has done fine over the last year. It’s decelerated a bit, but recession hasn’t materialized by any means here in the U.S. I’d say one area that we were a bit more optimistic on was Europe, and that hasn’t played out as much. So European growth has really slowed down. A lot of that is due to a slowdown in manufacturing that’s emanated from Germany in particular. We thought there would be a bounce back. We thought that a lot of the headwinds that we were seeing were shorter term in nature and it’s become clear that these have become larger dynamics. I would say in Europe in particular is that the services sector and the European consumer have actually done pretty well. I think the way that’s really been counter-balanced by the manufacturing sector has been a surprise. The manufacturing sector has really struggled.
Ben Jones – Later, we’re going to hear more about Germany’s manufacturing woes but, before we move forward, it’s important to note that last year’s paper had one central theme and this year’s paper does not. It identifies a half dozen variables that participants believe are going to influence outcomes over the next three to five years. Specifically, some of the broader headwinds that were concerning this year’s Forum have to do with the fall of globalization and the rise of populism. Since the Forum took place in London, a great place to start was to ask Mike about the discussions around Brexit.
Mike Dowdall – I won’t make any near-term predictions on Brexit because I’ll be wrong within minutes, I’m sure. So we tried to keep the Brexit discussion focused more again on the medium to longer term. In terms of the implications of Brexit, the first thing is it’s really increased the polarization that we’ve seen in the UK. You see people really lining up on deal or no deal, and it’s really a binary choice, and that just creates greater tension. You’re also seeing a bit of a realignment in some of the political leanings as well because it’s a little bit less around historical party loyalties and more again around deal or no deal Brexit, or really Brexit or not as well. To that extent, we’ve seen polarization and that’s broadly not a great thing within the UK. But at the same time if again you look at the UK electorate, it still remains a highly educated country with relatively flexible labor laws. It has London, one of the great financial centers of the world. There’s a lot of positive dynamics within the UK. So no matter what form Brexit takes, if it even takes any form at all, we still think that the UK is going to be okay. And again you also see the two sides, the UK and the EU, they both want to have some sort of relationship when this is all done. It’s in their best interests to have a relationship with minimal friction. So from that standpoint, the UK is going to be okay, it’s just going to be a bumpy road from here until that really gets cleared up.
Emily Larsen – And so that’s why it’s one of the major influences in terms of the global economy over the next three to five years.
Mike Dowdall – Yep, even after this is all done. Once there’s a trade agreement and whatnot, companies are still going to be figuring out how this works, how the UK fits into the EU, and so there’s going to be this overhang of uncertainty and it’s going to be hard for that to just go away. So from that standpoint, Brexit will continue to be something that matters within the market, and we think that it’s something that we need to look at closely when we’re looking at what’s going to happen in the world over the medium term.
Emily Larsen – Did you sense any particular concern from the people who were at the Forum who actually reside in the UK, or did they have a unique view compared to your own?
Mike Dowdall – Yeah, I mean — We were in London in September and so it felt all-consuming. That’s really all anyone talked about was Brexit. And so I’d say there wasn’t anyone we talked to who wasn’t concerned about Brexit in some way. I think that from that standpoint it was interesting to see how much it’s really taken up in terms of political bandwidth, but also just bandwidth of just normal people living within the UK. So we’ve seen, if you look at in particular like business investment, that’s really been stifled by Brexit because there’s uncertainty, because there’s a lack of conviction about what’s going to happen. From that standpoint, businesses just haven’t been reinvesting back into the UK. So we saw that. Also with their colleagues, we have colleagues in from the Netherlands and Portugal, so EU countries, and colleagues in from the UK, and so interesting to see that dynamic play out where they had I’d say very different perspectives, but who were — I’d say the one thing they shared was they were both very concerned about how this was all going to play out because it had ramifications for anyone within either the EU or the UK.
Emily Larsen – Certainly. Still on the theme of concerns is the next topic, is this globalization, is the end of globalization near, is this regionalization growing? This, I thought was a fascinating topic to just think about the implications.
Mike Dowdall – Yeah. There are definitely wide ranging implications for, again not a reversal in globalization, but a slowdown in globalization. What we’ve seen is this rapid globalization that’s occurred over the last 20 to 30 years in particular. And even economists who were very pro free trade, say in the early 90s, one that’s easy to point to is Paul Krugman, are now really re-thinking their ideas around globalization and whether unfettered globalization has been a good thing, at least at the pace that we’ve had it at. Globalization, from a pure economic standpoint, has been very much a positive for global growth. In aggregate, it’s definitely helped spur global growth. The issue is that the wealth that’s been generated has not been evenly spread. And so what we’ve seen is that the globalization and what’s occurred, we think that that really leads into populism as well. Because the people that have least benefited from globalization have been the middle class within developed markets. So you can point to Brexit as having some links back to the globalization that we’ve seen as well. It’s hard to say it hasn’t been positive for aggregate global growth. But when the distribution isn’t even, it tends to lead to anger, and that then can feed through into politics.
Emily Larsen – And so fueling the regionalization, what are the factors?
Mike Dowdall – Yeah, so what we’ve seen as well is that there has been a growing regionalization. Some of that is due to the China/U.S. dynamic where China is really starting to want to basically show their dominance, especially within the region of the world. Whereas the U.S., really since the Berlin Wall went down, has had hegemony so they’ve been able to be the number one world power. This has created a bit of a clash and we have seen regionalization where the U.S. kind of has their sphere of influence, China has their sphere of influence that’s in particular growing. So from that standpoint, it does slow down globalization in some respects and makes a more regional story, but it’s also an interesting dynamic because there’s also other areas of the market where you can see this occur. One we talked about in particular was around technology. One risk we see occurring is that you have the U.S. and Western Europe and then you also have China being a separate, basically, platform for technology. And what that means, where you see potentially technology companies then have to pick which sphere of influence are they going to operate in, whether it be the U.S. and Western Europe or China. And so it just creates more friction and it slows down that broader globalization that we’ve seen.
Emily Larsen – Polarization on another front.
Mike Dowdall – Exactly.
Emily Larsen – I think I can fill in the blanks but, just for fun, are there clear winners and losers when it comes to then globally this regionalization trend?
Mike Dowdall – Large multi-nationals basically took it for granted that they could have these large supply chains, sell into really whatever market they wanted, and a lot of them probably need to re-think that. And so they might not be able to have these large supply chains, they might need to once again make these supply chains more local. That’s one thing that’s been re-thought I think by a lot of larger companies. A lot have changed where they manufacture things. Some have moved from China to Vietnam, or they’ve moved to North American to Mexico. I’d say in terms of the winners, it’s hard to pick really who that would be. Companies that are able to change to this new normal and really can be operating in any sector are the ones that probably will be able to win from that standpoint.
Emily Larsen – This year’s Forum highlighted a growing consensus that monetary policy may not be the end all be all, and that a shift towards financial policy is on the horizon. We’ve seen this implemented successfully in the United States, and now the questions are about whether and how it will shake out in Europe.
Mike Dowdall – So what we’ve seen is central banks in many ways are pretty close to tapped out. If you look at some of the major central banks, the Bank of Japan, the European Central Bank, both of those central banks are operating with negative interest rates. They probably can’t reduce rates much more from here. So from that standpoint, if they don’t have the interest rate mechanism, maybe they can start buying assets. Well both central banks are already buying assets as well. How much more can central banks do? In many ways we’re at or close to the limits on what monetary policy can do to spur demand. Considering that the central banks are operating really with the pedal to the metal, you’re just not seeing particularly great growth as a result and factor of that. From that standpoint, what’s the next lever that can be pulled? We think that fiscal policy is that. So we saw in the U.S. there was a fiscal expansion, in particular in 2018 but also in 2019, and we’ve seen the U.S. outperform the rest of the world. And that is not a coincidence. At this point, we think that Europe in particular is probably a great candidate to also institute greater fiscal policy. The issue is that the EU has pretty stringent rules around budget deficits and also what we’ve seen is that Germany, who is probably the one who has the most scope for greater fiscal expansion, is very reticent to actually pull that lever for historical reasons, political reasons, and it just doesn’t look like they really want to step in at the moment. We do think eventually you will see fiscal policy come through, it just might take a recession for that to occur, which isn’t great. But there is scope for greater fiscal stimulus; we do think that eventually happens. The trigger for that, I’d say, is probably going to take somewhat of a downturn.
Emily Larsen – And were the people in the room kind of all in consensus about their feelings about this shift or the need for this eventual shift?
Mike Dowdall – Yeah. I’d say there’s cautious optimism that fiscal policy will come through. I’d say where we’re a bit more pessimistic is that it’s going to come through in the near-term. Again, if you look at Germany, it’s kind of the easy one to look at because they do have the most scope for more expansion in their fiscal policy, Germany understands that and they are looking to invest more and expand their fiscal stimulus. Where they’re looking is small scale tax cuts and in green investments, but it’s really not large scale investment that they’re doing in green technology. So they understand they need to invest more, they’re doing a little bit, but they really don’t feel like they need to be doing any more than that. From that standpoint, maybe it has a bit of a positive effect on the European economy, but it’s really not enough to shift it into the next gear.
Emily Larsen – Tell us about why Germany pops up in one of these key themes for the next three to five years.
Mike Dowdall – Sure. Germany is really interesting because we saw the German economy really, since the financial crisis, has been growing and has been one of the best economies in the developed world. What they’ve been doing for the most part is they’ve been building out their manufacturing economy and exporting within the EU, but in particular to China and also the U.S. Now what we also talked about was the slowdown in globalization, and this idea that exports are plateauing a bit and Germany has really been the number one economy that you can see that dynamic playing out. Because their manufacturing economy, which has really been driving their growth, has slowed considerably. And that’s had to do with just the slowdown in globalization overall. And so the country model of manufacture and export has not worked as well over the last year, and we’re not sure it’s going to work as well over the next few years as well with the dynamics that we’re seeing play out. Germany has really caught a cold, in many ways, because of this. One thing that we discussed a decent amount when we were there was this idea that maybe the baton in Europe gets passed from Germany to France. One of the reasons why Germany has done so well over the last call it two decades has been they instituted labor market reforms in the mid-2000s that helped to really spur their manufacturing sector and also make the economy a bit more flexible. That really helped drive the last two decades of German leadership. What we saw in France was they also instituted some labor market reforms over the last year or two and we’re starting to see some of those dividends play out in the French economy. The other thing that France has is a better demographic picture than Germany, and they’re not as beholden to globalization as well. So we think that potentially over the next decade this could be where France starts to lead the EU. The other thing that I’d point out as well is just around Germany is very much dependent upon car manufacturing. And so we’re seeing these wholesale shifts in what car manufacturers are investing in, and that’s electrification and moving away from fossil fuels. What Germany was very good at was the internal combustion engine, and where they really had dominance as well was in diesel engines, some of the highest polluting engines as well. So from that standpoint, the German car manufacturers are really trying to make that shift into electrification and trying to get ahead of the curve, but there’s no guarantee that they’re going to be the leader in this next phase of vehicle manufacturing. So German manufacturing does have some headwinds potentially with these changes that we’re seeing within the market. To the extent that German auto manufacturing is not the leader in this next phase, and that remains to be seen, that could have knock-on effects on German manufacturing, the supply chains around German vehicle manufacturing, and German manufacturing employment as well.
Ben Jones – From German vehicle manufacturers to Greta Thunberg, recognition of a need for widespread decarbonization has exploded in Europe and the rest of the world. There are countless investments and business opportunities in the green energy transition to come. So climate change showed up as one of the key themes at this year’s Forum.
Mike Dowdall – We’ve talked about decarbonization and the future of the energy industry for a number of years now. We focused on it even more this year because it feels like there’s more or less a seat change in terms of the attitudes of not only just people and citizens, but also we’re seeing a change from corporations and political leaders as well in terms of decarbonization. Europe just went through its hottest month on record in July. It also had its hottest June on record. So in Europe in particular this is a huge deal. This is a trend that is not going away. If anything, it’s picking up pace at the moment.
Emily Larsen – I re-read the parts of the paper that I have this morning, and my notes on this particular section are like societal pressures, peer pressures, global governments — you know like now there are enough forces in play, like you said about Brexit, it’s consuming the minds of people. It is now starting more so than ever before to be consuming the minds of citizens throughout the globe.
Mike Dowdall – Very much true. If you look at Germany, what’s happened is you’ve seen a rise in, not the Euro-skeptic parties, you’ve seen a rise in the Green Party. A lot of that has occurred over just the last year, and this has become the number one voting issue for many, many people in the world. It’s been really climate change. People are very worried about it and they want to see leaders, both political leaders and business leaders, tackling this. From that standpoint, this is really going to be a big issue over the coming decades, is who can come up with a plan, number one, and can you sell this plan as well to the citizens. It’s not going to be a smooth transition either, because what we’ve seen is, in France you can look at it, they imposed a gas tax. And some of that was to raise revenue, but it was also essentially a carbon tax, and there were huge protests around that as well. It’s not going to be just a smooth transition, and it’s going to be easy to move towards decarbonization because there’s going to be winners and losers. And there’s also, to be quite frank, there’s going to be higher costs for a lot of people because to move away from carbon, fossil fuels, is not going to be cheap.
Emily Larsen – So there are varying degrees of impact on the different sectors. Can you talk a little bit about what the discussion was in terms of who could potentially be the biggest losers here or the biggest winners?
Mike Dowdall – Yes. So one area we talked about a decent amount was utilities. What we’ve seen is utilities are very much moving towards green energy. One of the reasons being subsidies. A lot of utilities have received subsidies for building solar panels, using wind power, things like that. But also part of it is that green energy has become a lot cheaper. If you look at solar prices, they’ve plummeted for years now. Wind has become a lot cheaper. I was actually just reading this morning that in Germany, they’re going to build their first non-subsidized solar park because it’s become that cheap. Where it can really actually compete with fossil fuels. You have the popular incentive where it just ingratiates you to your consumer, but you also can actually now make a profit by using green energy. That combined has really moved a lot of utilities towards green energy. They are someone that could be on forefront here. If you look at the losers, it’s pretty easy. You can look at some of the large — it’s actually not even necessarily the large oil majors, it’s some of the smaller ones. Or you’ve seen a lot of struggles from frackers here in the U.S. over the last year or two. Some of that is around production issues, and oil prices are at middling levels. But they’re going to be under pressure over the coming years because investors are trying to get in front of trends. If you look at where the trends are going, the trends don’t look fantastic for oil producers, in particular once you are dependent just on oil and national gas production. So, there’s a premium around those companies. Over the medium-term into longer-term, that’s just not where the future lies. So that’s something that you look at as being a loser over the longer-term. I’d say overall, it doesn’t necessarily mean that some of the obvious sectors are going away any time soon. This transition is over a multi-decade period. During that period, we’re going to need fossil fuels to actually get to that future. I think it would be naive to say that a lot of these oil companies are going away over the near-term and that’s not the case. A lot of large oil companies, too, know where the future is going so they have invested in green technology. They’re trying to build out segments of their business that aren’t as reliant upon fossil fuels because they’re not stupid. They know that fossil fuels are not going to be the main driver of energy by the end of, say, this century, but it could — it’s going to be sooner than that.
Emily Larsen – Given the time horizon in terms of when people think they can truly affect change and transition completely, it’s a much longer-term. Do you anticipate that this will be a theme that will continue to come about in these global events and Forums and be discussed?
Mike Dowdall – No, this isn’t going away by any means. In terms of the timelines that we discussed, if you look at the Paris Climate agreement, what they laid out was right now, there’s been a 0.8 Celsius rise in temperatures over the industrial period. Their goal is to — the stretch goal is to limit that to 1.5 by 2050. That’s going to be tough to hit. Because that would also mean that we’re basically at net zero carbon emissions within 30 years which would be tough. There’s always going to be carbon emissions. That would also mean we’d have to have huge development in carbon capture, large scale rollout of green energy for electrical grids as well as electrification of most major transportation and homes and what not. It’s a really big stretch goal. Now, that’s something that’s not completely out of the question but it’s really going to rely upon a wholesale change in peoples’ attitudes, what people are willing to sacrifice between now and then, and getting business and countries aboard to really reach that. It’s going to require a lot of coordination from here until there.
Emily Larsen – The themes discussed at our global investment Forums are likely to be relevant for years to come. A big thanks to Mike for his take on these topics and for giving us a peak into the discussions from this year’s Forum. To wrap up, we’ll bring it back to the U.S. and leave you with actionable ideas for you and your clients’ portfolios over the medium-term.
Mike Dowdall – Is the U.S. really going to de-couple from the rest of world — which they’ve done or are they really going to get dragged down by the rest of the world? What we came to is we think that the U.S. most likely continues on at this muddle through pace. And it continues to probably be a leader in the world. One because of the technology leadership and also because again the U.S. consumer continues to be the bright spot in the world economy. We just don’t see that really changing at least if it was in the medium-term. We still see strong employment and we don’t think that reverses in the near-term. We also see that it’s the U.S. consumer who is actually been able to save a bit over the last few years. It’s just a bit more resilient and can take on some of the shocks that maybe over the last cycle they weren’t well placed to take on. There are risks. The manufacturing weakness that we’ve seen could spill over to the rest of the economy but manufacturing in the U.S. is only 10% to 12% of the economy. It’s not a huge part of what we do. Employment is even smaller in the manufacturing sector.
Emily Larsen – How does the trade situation factor into that discussion?
Mike Dowdall – It hasn’t been significant but it has been a drag in really two ways. One of them being it’s increased costs for consumers. Where we’ve seen it actually show up probably more so has been around business investment and business sentiment. Businesses are stepping back. They aren’t investing as much as we’d expect at the moment because they don’t know what’s going to happen with trade. From that standpoint, we think that that’s probably not going away unless we get more of a larger scale trade deal materialize. But from those two standpoints, we think that a lot of the bad news has been priced in. A lot of the negativity we’ve seen show up already. And so we don’t think the trade by itself can drag the U.S. into recession. It more just provides a headwind for the U.S. overall. Now, there’s always going to be uncertainty in the market and businesses just learn how to deal with uncertainty. It’s a bit of a cop out to say well, trade tensions hurt our fourth quarter earnings and investors aren’t going to rely upon that much longer. So businesses just need to learn to operate in that world and they will learn to operate in that world where they know this is what it’s going to look like, this is what it’s most likely going to look like over the coming quarters, plan accordingly.
Emily Larsen – I feel like that’s also the same for the end client that our advisors, our listeners are working with. It feels like there’s more uncertainty than ever before when you listen to the headlines, when you’re watching CNN. It all seems so overwhelming and that’s what some of their customers are coming into them with those points of reference. How do you calm them, how do you get them to the new normal of everything is going to be okay? This is just — we need to evolve to this point that this is the new reality.
Mike Dowdall – This sounds like a therapy session. So, what we always joke about within the team is that bearish arguments always sound really smart. It’s really easy to get really negative on the world and just say everything is going to be bad, and just sell all my stocks, and go into cash. That’s always something that I think investors need to think about is one, does that make sense over the medium-term, and two, is that really the best move overall. You can look at these uncertainties. You can always point to them. But if you look at the world over the medium-term, that’s where it’s really nice to have this global investment Forum. Over the medium-term, things look okay. It’s hard to get very bullish about the world when you have all of these headwinds facing us. We haven’t even gone into U.S. politics and the 2020 elections. But you look at the U.S. consumer, they seem okay. You look at the European consumer, they’re seeing wage growth, they’re seeing low unemployment rates. Yes, the manufacturing sector has dragged down the European economy but the European services sector has done just fine.
Emily Larsen – It sounds like the advisor can help the consumer customer client with perspective. Things that are attention grabbing in the headlines of the news or on the newspaper is not the longer-term where things are actually still kind of steady as she goes.
Mike Dowdall – Exactly.
Emily Larsen – That’s not grabbing the end client’s attention and the advisor can play a really good role in looking back historically over the medium and long-term and watching how the economy, locally and globally, has grown. Can we talk about actionable ideas for those advisors and the portfolios they’re managing for their clients, what can they do with this information that they’ve learned about this discussion during the Forum.
Mike Dowdall – Yeah, if you look at 10-year yields, they look pretty rich overall. When we were looking at the German 10-year at negative 0.5%, Japanese 10-year negative as well, it does look pretty rich overall. But we do like within a multi asset portfolio, just having that cushion overall. To the extent that it’s going to be a bumpy road, which it most likely will be, we think that it makes sense to be more or less neutral on duration overall, and overweight on equities. We have a few sector calls as well within credit. One of the areas that we discussed within the Forum was we’re a bit concerned around leverage within the U.S. financial system. In particular, corporate leverage. We do have a bit of an underweight towards U.S. high-yield but emerging markets continue to have that strong dynamic. We do see scope for emerging markets central banks to actually ease a bit. If developed market central banks are a bit tapped out, emerging markets central banks have a bit more than they can do to boost demand. We think that that should be positive for emerging market debt overall. So within credit, it’s a bit of a relative value play within the portfolios. But overall, I’d say we have a mildly positive stance, and it just ties back to this idea that the world economy is operating at a lower gear, but it’s okay.
Ben Jones – Thank you for listening to Better conversations. Better outcomes. This podcast is presented by BMO Global Asset Management. To access the resources discussed in today’s show, please visit us at www.bmogam.com/betterconversations.
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