A Market Cycle in a Month — What’s Next?

First Republic Bank
August 4, 2020

Watch a conversation on the capital markets with Christopher J. Wolfe, Chief Investment Officer of First Republic Private Wealth Management, and Mike Selfridge, Chief Banking Officer of First Republic Bank.

Read below for a full transcript of the conversation. 

Mike Selfridge - Well, welcome everyone. My name is Mike Selfridge. I am the Chief Banking Officer at First Republic Bank and I want to thank you for joining us today. I think we've got a great presentation with a great presenter and that is Christopher Wolfe. Before we get into that, I just, again, want to thank you all for allowing us to serve you at First Republic Bank. It truly is a privilege and we would not be here without you and we recognize that. We also just want to send you our best wishes in a very challenging time and wish you safety and good health and strong endurance. So getting into today's presentation, we have the topic of a market cycle in a month and what's next and it's obviously been an incredibly tumultuous, let's call it six months and a lot of different opinions as to what's next. So I'm delighted to have Christopher Wolfe join us here on this presentation. Christopher is the Chief Investment Officer for First Republic Bank's Private Wealth Management Group that is 156 billion in assets under Management Investment Platform. Chris leads the research, the strategy and the investment decisions for Private Wealth Management. He is an influencer and an expert on these topics we're about to discuss, the economy, the markets. You may see him frequently on television networks and in publications. So before we get into it, I just want to draw your attention to the Q and A button on zoom. If you're on an iPad, it's on the top. If you're on a computer, it's on the bottom and what we'll do, I'll go through questions and answers with Chris but we would encourage you all, what's on your mind? Please submit those and we have our team from marketing that will be able to serve those up to me and ask Chris. So without further ado, Chris, how are you doing today?

Chris Wolfe - Wonderful Mike, I very much appreciate being here. Hello to everybody and that was a wonderful introduction. So thank you, looking forward to it.

Mike - Good, well Chris, maybe I'll just start, you and I used to go on the road a lot into individual markets

Chris - We did great.

Mike - And do this Q and A, this is our second virtual one and it's always a pleasure. I guess I'm going to go into a lot of things related to the U.S. economy, the stock market, and interest rates. I would like to start with, I guess the biggest headline today is that the gross domestic product drop at a 35%, 33% annual rate. It was a massive drop. And so it's been interesting to watch the optimism and the waning and the optimism, back to optimism and now I would say the headline number today in terms of gross domestic product, 33% drop as compared to a year ago. That's pretty devastating, so maybe we'll just start with the macro US. How do you interpret those numbers?

Chris - So that's a great question, Mike. I think a couple of things are important about today's numbers. The first is GDP, so gross domestic product reports are backwards looking. They tell you what happened. I think that's important though to understand the magnitude of what we've seen. You'll hear headlines, hey, it's the worst since the great depression or this is the largest quarterly loss that we've ever seen, et cetera, et cetera. And a lot of that is to sell papers. The reality is a lot of the data that we saw in May and June and parts of April anyway, suggested we were going to get this kind of a number. So that's kind of one thing as this is backwards looking. Does that mean it's not a bad print though because it gives you a sense of the depth and magnitude? Remember this is an annualized number. So they took one quarter and then they kind of multiplied it by four to get to this very large number. I don't think that's what we're going to see throughout the whole year. So if you fast forward the remainder of the year, there has been some rebound in the things that help make up GDP. Things like consumer spending helped by the PPP and the stimulus checks, those need to continue by the way and I know we'll touch on those. But our view is that we're going to see some rebound by the third quarter and that we may not get everything back here, but there's already been some signs that that minus 32.9%, which is all over the press is going to be look like a really big number in the third quarter, maybe plus 18, plus 22, or something like that which also will be the biggest kind of headline going forward.

Mike - So Chris, that's interesting, Q-three Q-four and even into 2021 and we're all picking letters of the alphabet as to what this recovery looks like. I could be curious what yours is. We've heard v-shaped w, l, Nike swoosh and question mark. Where are we headed?

Chris - You know, I come up with a new one. I think it's the letter e and the letter e is for endurance. We really need to think about this as a long-term type of thing. Some of the latest data, and I know we're going to go right in this direction around the COVID infection. It really suggest that it may be with us for quite a long time. And even if we do have a vaccine which I hope is in the next 12 months, there're some that think it's a little bit early, we want to be a little cautious with that. Vaccines, according to some of those most noted epidemiologists don't happen all at once. It's not a light switch, it's a rheostat. You kind of turn it up and up and up and we all know that there are parts of the healthcare system where people make individual choices, some of them may make choices not to take the vaccine. So the eradication of COVID is not something that we would anchor our expectations for recovery or what we think that investors should be counting on. But rather than management of it. And that can still be a good thing because we have such depressed levels of sentiment, the high levels of fear and anything that goes to address or beat those symptoms tends to help the economy, intends to help them market. So, but a return to pre COVID say, November last year, that doesn't seem to be in the cards here, no matter how much we may wish it. If that virus has some endurance, that means us as individuals, but I think more broadly the economy, we'll need to endure it. And I think we have the tools, the technology and the willpower to do that.

Mike - How well can the economy endure here if that's the case? And a little bit, your thoughts on the vaccine, we've all got our thoughts on it. But I I've heard you say this is not a financial crisis like 2008 where the banks were at the center of part of the problems. This is a healthcare crisis. What's the solution for a healthcare crisis?

Chris - It's a biological event that requires a biological solution. What's really caused the harm on the GDP is the actions that humans took, shutting things down, et cetera arguably necessary, had to do those things. But the duration of the shutdowns is what's changing all the economic functions. I think one thing though, that's important is, kind of history is a good teacher here. Despite World Wars, despite a lot of things that have gone on over the last hundred years, the U.S. consumer has been a pretty resilient spender. They don't spend all the time but the reality is, they spend a very high proportion of the time like 90%, nine times out of 10 on a year over year basis, they're spending more than they did last year. Now there are some limits around that when you think about different parts of the economic cycle but we're in a place where there's also a lot of help. There's very low interest rates, there's a lot of stimulus that's coming from the fiscal side, yeah, there's a lot of debt we're going to have to deal with. But at least for now, we're in a place where that consumer story has actually starts to flow through the economy. We see it in some of the bank credit card data, we see it retail sales numbers, and we see it in gasoline purchases. A whole panel of data suggests that things are moving back in that way so that we're in a place for I think most investors’ confidence about an upward arc, an upward trend in the economy is reasonably high. I think what remains to be seen is how does the virus impact that arc? And one of the critical questions there will be whether or not there's immunity, et cetera. But for now a combination of stimulus, a combination of kind of history consumer spending puts us in a reasonably constructive arc I think, as we're going all the way into next year. To bottom line it, I think we're going to have GDP this year after the whole year is done down about five to 5 1/2%, something like you were at the end of next year, full year, not just one quarter annualized, but just the whole year at once. We're probably up 4 1/4 to 4 3/4, something like that. We don't recover everything we lost in one year. It's going to take some time and that's really the key here for that letter e, the endurance,

Mike - I want to get back to GDP, I appreciate your thoughts. But you, you touched on consumer and fear and as you know, this U.S. economy is 70% driven by us as consumers. 21 million people let go 1/3 of those jobs have come back. That's progress, but that's still 11 plus percent unemployment rate and if you look at the consumer, and I like to look at the University of Michigan consumer index that dates back to 1966, that being the beginning of the index. I assume when they pick an index, it's sort of a Goldilocks year, not too hot, not too cold. But when routinely in that number was sort of coming in closer to 100 and then plummeted to 72, '60s, inched its way back up to 78 in June and now here we are in July. It's suggested the psyche of the consumer was coming back a little bit but you mentioned things like credit card data. What are your thoughts on the consumer that's really going to help us move forward in a positive direction?

Chris - Well, there's a confluence of things that are happening here that I think will affect the consumer data. The first is and just immediately will be the additional stimulus package. Republicans have proposed one thing, Democrats have proposed another. We think in the interest of the country, they'll find a solution. It just may take a little bit longer. In the near term, what that may create is a little bit of turmoil, some uncertainty as the checks may not arrive on time. And I think many people would be rightly concerned, you worry about your car payment, your rent payment, etc. So the reality is that's coming kind of step one that will help stabilize things. The duration of that though is still not knowing yet. It may be just another couple of months might get us closer to the election. But that's not that's not anything more than a salve or a band aid because we can't keep permanently borrowing and paying people. I know some people who wish that, but we can't do that. Somebody has to buy all the debt that is issued in order to support these kinds of things. So we're in a place where we're going to have to understand how the job market might transform. And here's kind of the tricky part. Much of the U.S. service industry is dependent on two things, some form of transportation and some form of communing, getting together. People getting together, restaurants for example, movie theaters you're communing. You're in a common location and that's how scale and those industries work. If everything is redistributed, we're all working from home etc. There're some interesting challenges around that. Everybody's got to have the same technology, everybody's got to have the same access. And largely that's kind of been the case but that's actually a redirection of investment in this economy towards individuals rather than towards things that are together. So I don't know that all of those jobs in the hospitality industry of which there were 24 million in total, you recover all of them. There are some permanent changes I think COVID has caused around behavior, around choices and consumers are showing those changes in the following ways. Even though when they get their stimulus checks, they're paying the bills, the rent, etc. They are also raising their savings. They're worried about another rainy day because by the time we get to end of this year, if the restaurant they worked at isn't open or the trucking company has got less business, they may have a role, they may not have a job. I think what it's going to have to lead to is in the next presidential cycle, the next Congress and the president, whoever it is, is really going to have to think about something like the EGTRRA act of 2000 or 2002. And that stood for the jobs, growth and tax reconciliation act, forget the acronym. It was really about giving companies incentives, regardless of what was going on to hire people back. And even if that meant they'd have to work from home. Why could something like that work? Well, a lot of companies have very high profit margins and I think that's the dynamic we're going to see over the course of the next year or so where the political will to help get people back employed met with the virus, which says, gosh, you shouldn't be together all the time because it spreads like a forest fire is really what we're going to see evolve. And will consumers save more, but also pay all their bills? They're making the rational decisions and that to me suggests that the arc is still okay for now.

Mike - That's good, Chris, thank you. I want to talk about Federal Reserve and stimulus and even stimulus globally. So because you touched on it and there's been so many forms of stimulus. We've had the Cares Act a little over $2 trillion, the Hero's Act $3 trillion. The Heals act is in the works, that's another trillion dollars. It's been a bit of an alphabet soup in terms of PPP which we were very proud of First Republic to play a part in. We helped over 11,000 small businesses through the SBA program. But programs like the TALF, which is buying asset backed securities, the CCF, which is buying corporate debt, the MMLF, which is buying money market funds. In the old days, and I'll go back to 2006. The composition of the Federal Reserve balance sheet was almost all treasuries. And today maybe it's 1/2 60% treasuries and it's all these other things, it feels like there's no limit to the amount of liquidity that the Fed is willing to put into this economy. So what are your thoughts on that?

Chris - If we could give an award to the most creative central bank this year, it would go to the United States Fed. I think in prior years, in the 1998, we would have given it to the Hong Kong monetary authority. In 2012, maybe to the Bank of Japan. Just coming up with new and very different programs that wait, what we never thought they would do that. Who would guess that the U.S. Fed is going to buy corporate bond exchange credit funds? That wasn't on anyone's menu anywhere. Why I say that with a little bombast in my voice is because the creativity of the United States Federal Reserve has been vastly underestimated by the markets. Jerome Powell, the chair is saying he is going to do what it takes a little bit like his Draghi-moment or Mario Draghi, the former chairman of the European Central Bank, Said that I don't think you should disbelieve him based on all the creativity and all the things that have been going on. Now, does it mean they're going to try to force markets higher to create a bubble? No, could that happen anyway? Yes, but I think the answer around Fed policy, there's a little bit of the Fed being trapped by their current mandate. A mandate has two pieces really but one of the critical ones is full employment. And what tends to happen after pretty big downturns is when companies go back to the kind of growth mode or recovery mode, they don't always hire as quickly. That's why I said a little bit about that EGTRRA act. But if they don't hire as quickly, and their revenues grows strong, then they tend to have extra profits. So that's interesting. Companies with extra profits have at least over the last 10 years tended to think very hard about do I hire people or do I deploy technology? And if you go back to a COVID world where everybody's working from home, a lot of the answer might be both. I got to invest a lot more in technology and that relentless investment in technology is pretty good for companies, but it also may mean we don't hire as many people back, and I think that's a big challenge. Circle back to the Fed, you don't hire as many people back and the Fed's got to have full employment, guess what? They're stuck and stuck to me sounds like interest rates low for a really long period of time. Like well into 2022 or potentially beyond as they're a little bit stuck by their mandate.

Mike - That's interesting. So let rates lower for longer and its interesting when you look at things like mortgages largely drawn off the 10 year treasury, that's 50, 60 basis points today. You compare that to Germany that's negative 50 basis points. In other words, I will buy a 10 year German bond and I will pay the government to hold my money for me. So you have all this negative yielding debt out there and yet the U.S. as a safe haven, still looks like a bargain at least for the long end of the curve. And you mentioned the Fed is going to keep rates presumably close to zero for at least another year and a half. What are your thoughts on sort of the yield curve and how that drives interest rates for things that we do like buying cars and buying homes?

Chris - Well, I think three things really out of all that. Number one is savers are likely to continue being punished. It's just very hard to save anything in an environment where interest rates are zero or even worse, taking risks for 10 years only gets you half a percent or 60 basis points. So that's the punishment of savers. That's a global phenomenon. And that makes some sense there's a lot of academic work that says "There's too much savings in the world and we can't pay our debts. We just need people to spend more." So we'll leave that argument to the side for a moment. But the saver is going to have a very difficult time. It will force them, if they're looking to make a return after inflation or their tax base to do other things. I think the second piece though kind of gets to the investment environment and there's other fundamental pieces, the inflation story isn't that strong. Even though there's a lot of money sloshing around, the reality is the thing that's inflating our markets, there isn't inflation in a lot of goods prices or a lot of other things just yet. And it really will take some scarcity of those things in order for inflation to pop up. And since we're not scarce of a lot of things, extra money doesn't really create that inflation. So we think we have more room to go before the inflation story picks up a depth. Around the income story is that there is one opportunity here and I think that's going to be, we're going to see a big refinancing wave and that's already started to happen in corporate America where they've turned out their debt or we're looking to refinance and capture lower rates here. And so it's a boom in some ways to the corporate sector and anybody that's been a borrower rather than a saver and in a very leveraged economy, that's not necessarily a bad thing. It keeps distance between insolvency and bankruptcy very wide and that's what we want.

Mike - So Chris, the questions are stacking up from the audience and some are very consistent with my questions of you. I think one question came through that healthcare crisis could drive us into a financial crisis quite possibly, but as we keep this stimulus up and I'll go to the global stimulus. As a percentage of GDP now, I think the last steps you might've published was that the United States is somewhere between 12 and 14% of our GDP in stimulus. Japan about 20% of their gross domestic product, Germany, 22%. Unprecedented amounts on a global basis. We are racking up a lot of debt on a global basis. Where does that end up? It doesn't sound too good.

Chris - It sounds like a lot of debt is what it is. It sounds like trillions globally of new government debt that we're going to be issued. You know, the real issue for debt when it's outside are circulating, is the owe to someone else. If you owe it to yourself, there are some accounting things that go on associated with that that mean that you can manage do I look to myself and how I pay it out. I think the bigger question though is with the accumulation of this much debt, there will be, I think, a reckoning, but it's years away at this point for reasons that are related to the politics which I'll get to in a second. But I think the economic consequences are fairly straightforward. It's that when you're busy repaying debt, you're not doing other things. You're not reinvesting, you're not doing things that might propel your economy forward. So debt acts like a giant weight and I think read your Carmen Reinhart and Kenneth Rogoff's book "The Financial Crisis Aftermath," Debt, you know, is one of those things that creates disinflationary impulses, tends to keep things lower and slower than they might otherwise would have been. So I think one of the things that we touched on earlier, you probably don't get the full rebound, et cetera. Is just that weight of debt going forward is going to be pretty pretty important. Here's the link, and this is my third point around politics. I think it becomes a political question when the cost of financing that debt starts to consume your budget. We talked about in prior calls like you and I to a year ago that this would become an issue. We were a little early, but with all the debt we've racked up now, it seems very clear to me that the next one to two years, the idea of how much interest that the U.S. government is paying at the federal level on a debt that we've already issued, which it will consume a bigger piece of the budget is an important consideration for political choices that we will lead out that. And that could be a forcing moment that causes us to think about some combination of higher taxes. Things like what's on the cards, but also lower spending in order to be able to manage that kind of law that will eat Cleveland called interest payments.

Mike - So in other words, we probably can as a country really afford to see rates go up too high, given the debt load and the debt service.

Chris - It would be challenging. So if you think about it now today, somewhere between six and 700 billion in interest payments that the United States government has to make on a gross basis, it's a little less than that on a net basis. But we're issuing a lot more debt and if you just have interest rates on the two year bond go from 25 basis points to a hundred, that's a lot by the way. Boy, what our interest payments skyrocket.

Mike - Yeah, let's shift gears. A couple of questions, Chris. The stock market is on people's minds and what's really interesting is, were in a recession clearly.

Chris - Technically.

Mike - However you want to define it, two negative consecutive quarters of negative GDP. But if we're in a recession, usually stock markets behave one way and bond markets behave the other way. And that hasn't been the case here. Bond prices have gone up and stock prices have gone up. And I just checked as of today and even with the market down today, I feel like every time we do this, the market goes down. So that's just a harbinger for the future. But, well, yeah, great buying opportunities for clients. S and P 500 year over year as of today, 7% NASDAQ up 27% year over year and the Dow Jones down just 3 1/2%. What's going on here and what are these multiple suggesting for the maybe a price earnings basis for the markets in general?

Chris - Yeah, so the markets have long heated the Pavlovian call of the central bank, which is lower interest rates, lower the cost of capital, lower your discount rate and all the financial formulas that go with it and what you get is a higher stock price out of it and I think that's important. So there's an immediate and direct response from the Fed pushing liquidity into the system, lowering the cost of capital and making alternatives like the value of cash. Remember, the savers is punished function, or even bonds not that attractive after taxes and inflation. So you're left with a word that we use called "angey", alternatives not good enough yet. There aren't a lot of them and so you end up in a stock world. And if stocks pay you dividends at 2% or 3%, gosh, that's six times the 10 year treasury and whoa, you start to make a different calculation I think for many investors and that's helped to propel markets higher. The other thing that had helped on the kind of back of the Fed's actions recently, but also the last several years has been companies with all their extra profits for buying back stocks that are a maddeningly large clip to the tune of two, three, 4% of shares outstanding every year. So arguably they would say that's a good investment. Those two things, the buyback tailwind, Fed essentially lowering the cost of capital have really jolted the market's higher. It's a natural response to those two things.

Mike - I'll close toward the end with how you're allocating your money and our money at First Republic or a client's money for that matter. A couple of questions here some thoughts on commodities and gold in particular and the client here is asking if that's a good hedge against inflation, which it is, but I guess it leads me to believe what are your thoughts on gold and what are your thoughts on inflation?

Chris - So let's talk about inflation and then we'll link it to golden broadly to commodities. So the idea of inflation I think at this point is one that many people are concerned about because there is so much money sloshing around in the system. But unless and until it gets in everyone's hands in a very large way meaning through stimulus checks or others, even to the tune of much greater than what we're doing today, it doesn't really have a huge effect on inflation. Example to just back up what I'm saying is Japan in the 1990s. They inflated their economy radically, lots of debt issuance, but they also said, "Banks, you have to hold most of it." So most of the money never actually got out into the Japanese system. And as a result, they suffered three years of disinflation, deflation, a little bit of inflation, it's very hard. Economists have called that a liquidity trap pushing on a string and a number of other kind of cute terms. But the reality here is that unless and until we get money in consumer's hands and they go back to their old ways of consuming the same kind of clip, it's going to be very hard to see a lot of inflation in the United States. And I see it's also a closed economy to a certain degree. You know, net exports and imports 10, 11% of the economy. So importing inflation coming from a dollar that got a bit weaker, I don't think is a huge concern either and most of our trading partners, the big five, we worry about currencies like the Yen or the Euro or the Canadian dollar and Mexican peso. And unless the dollar crashes against all of them at once, it's very hard to talk about imported inflation. I think it's a nice thing conceptually from the textbook, but an unlikely reality at least in the very near term. That said, the inflation story is one that we don't want to lose sight of because there are things that are bubbling up like healthcare costs. Prior to the affordable Care act, Healthcare inflation was running five, six, seven, I think one year it ran at 12%. Woo big, it also had a consequence. The largest number of bankruptcies in the U.S. was healthcare related for a decade running. Go to hospital, get appendicitis, come out with $85,000 bill and declare bankruptcy. That's a little glib but it does get to the nature of these healthcare costs and an aging population are an inflationary item. It's a scarce resource, we're running out of doctors, there's a lot of issues around all that. So I wouldn't say inflation is dead, but the things that drive inflation, healthcare costs and potentially commodity prices are important to watch, particularly if the U.S. keeps this we're going to go it alone and argue with every country individually rather than trying to be more globally oriented. There are some risks around commodity prices rising and those two things, healthcare and commodity prices hit consumers the most.

Mike - You know, it's interesting, Chris. Oil to me comes to mind. It's a very stimulus oriented type commodity. But the interesting thing are we using oil? So Western Texas intermediate right now is $40 a barrel, that's low. It actually went negative 35, didn't it in April? You could explain what the heck happened there but all the things that drive the consumption of oil like us taking vacations or the airline industry, I tracked the TSA tracker and as of the 29th of July, 573,000 Americans went through air, people went through the U.S. airports. That's off from 2.5 million at the same time last year, way down. So back to consumer and spending and stimulus and then oil is a commodity, is this also a lower for longer situation with oil in your opinion?

Chris - I think so, there's a couple of things that probably keep the oil price at least on the fundamental basis, relatively low. A lot of excesses in the U.S. still plenty of shell and other types of oil, number one. Number two, technological advances around things like electric cars, etc. are rapidly coming online. We went from 0% electric cars in 2000 to now we're at a couple percent. I mean, it's rapidly moving up. You're also talking about distributed power, Tesla batteries, solar roofs, that types of things. Those things are only set to grow because now they're economically viable without subsidies. So I think the real demand for oil ends up coming from emerging markets to some degree and oil at low prices probably lasts for a while for those kinds of reasons, a lot of supply. Now one caveat is that there's still a lot of politics involved, particularly around Middle East, et cetera. And so for a variety of reasons, we'd expect oil to have some episodic and potentially volatile periods over the course of the next several years. But I think on a fundamental basis, hard to see oil 70, 80, 90, $100 or more. And the longer term problem for that is countries like Russia or Saudi Arabia need oil at much higher prices to make their budgets work. And there's a lot of other consequences that happen when those countries' budgets don't work. And so it's a little bit of a concern for us as low oil prices. But overall, it's good for U.S. consumers and that kind of ties back to the transportation and other stories even though we're not using it as much, lower energy prices do help. One thing about gold really quick, I think something they mentioned that gold has really worked on a couple of things. Central banks have been buying aggressively in the last six or seven years or some good data from Goldfields and mining services. In jewelry market is actually slowed down a great deal over the last several years as well. That confluence of things has helped on average to push, gold higher at a little bit of dollar weakness and a little bit of economic surprise data, which is good coming out of Europe. But I think you have a little bit of this demand function. Couple that with political instability in the two biggest trading giants, I used the term, I think on Bloomberg, two elephants fighting in a forest, they're going to knock down a lot of trees. The two elephants are the United States and China. You're going to get some folks very concerned that you need a store of value because there are some consequences should the U.S. and China decide that they ultimately don't want to get along. And gold in some cases make some sense in that line of thinking. Three to 5%, for a period of time is not bad, but anything over 10 years, you might as well just buy stocks. In almost every instance we've looked at over the last eight years has better off with stocks. It's very rare where gold beats everything else for 10 years and something else really strange would have gone on at the time and we just don't see those signs yet. So it's more of a tactical play.

Mike - I want to follow up, we're getting a lot of questions on politics. But before I go to November, you sort of touched on China and the U.S. And I'd like you to dig a little deeper there. It's been interesting. The closing of embassies from each country, some of the escalation of military activities in South China Sea and of course, trade tensions. Do you just see this a little bit of a cat and mouse game or is this potentially going to escalate into something larger that could impact the economy in a more negative way than its already impacted?

Chris - You know, that's a great question. I would have said before the embassy closures that this was more a cat and mouse and that there's a way forward. I think a lot now, given where we are in terms of time, it's almost August, and we’re just 93 days away, 94 days away from the election. That if you're China, you're going to just sit tight and wait. There's no benefit coming back to the table, you have aggressive trade hawks in Lighthizer and others. There's nothing, you might as well just wait for a regime change if you think that's going to happen. Otherwise there's nothing really lost in the next couple of days around it. That said, I think some of the claims that Republicans have made and others have made around intellectual property theft, et cetera, those are longstanding issues that have not gone away. And there has not until recently been any really good resolution around these things. And I think that remains to be seen. That's still a major concern not just for Silicon Valley, but also I think for folks looking at what's the dynamic, the relationship between U.S. and China. My sense is that they say the word permanent, but there's long-term damage that has occurred and that the U.S.-China relationship will end up being different regardless of who is elected president in November. And that difference to me sounds a little bit more like a frenemy adversarial approach, which is something that the U.S. has dealt with other regimes, Russia, for example, that may have much more economic consequences that we don't see yet. And why do I say it that way? Because China has proven adept at fighting asymmetrically targeting counties in Iowa, for example, that produced soybean and say, "We're not going to buy soybeans anymore." So an age of information to expect kind of blunt force trauma to your trading partner, U.S. to China and China back and have that work, that's the paradox of power. The more you bring force to the table, the more someone's going to respond in another way that you may not have expected in order to try to keep things in balance. So we think there needs to be a dialing back at the end of the day of the current situation and maybe a reset, almost like a detente that we saw in nuclear talks in the 1980s. So that's where I think we stand. For now, it is what it is and with everything in a COVID today, they're both relatively closed. The effects are not that great on the U.S. economy.

Mike - You mentioned politics and our questions that are coming in on politics mainly, what is the impact and we've got two scenarios obviously, right? We've got to Biden election or a Trump election. How does the market react to that? And what are your thoughts in general in terms of changes in policy and then of course the politics of it?

Chris - Thanks Mike and we've talked a lot about this with clients. You know, its policy that matters, not the politics. The slanderous stuff on TV, the cesspool that is some of the online services where it was just back and forth. If you get wrapped up into that, I think you lose your mind. But the reality is policy matters. So how do we know this? Well, chump Trump changed corporate tax policy. He changed EPA regulatory policy, changed financial oversight policy. And by the way, all those things ended up being economically speaking margin goods for companies. They may not have been social goods, but those were irrelevant in the decision making process. So policy matters because it actually helped to propel the stock market when you got a margin expansion in a low growth environment because you didn't have to do so much reporting or your EPA standards changed, or your permitting process changed. So I'm not going to comment on those things socially, but the economic impact is very clear. It helped companies. So to the extent those kinds of policies change, mostly regulatory, that is something that I think we'd be concerned about. Those are margin reducers kind of straight up, you give up what you gained. But I think more importantly, there's been such a panoply of things that have gone on in this administration from tariffs to negotiations to this, that that's a lot of uncertainty. So one thing that may happen if there's a democratic president is you may just see less uncertainty. And less uncertainty looks like, okay, we have a clear policy, we're going to handle China this way, we're going to start being friends with Europe again, because they're not our enemies. We're going to figure out how everybody can win in this trade environment. That's such a radically different position than where we are today. By the way, that level of uncertainty going down raises business sentiment, raises the chance for reinvestment, raises the chance for hiring. We need to see those kinds of things and that's not exactly where we are. So that's why policy matters because it can affect GDP, it can affect growth, it can affect profitability, and it can affect hiring. I think the scenario though that's the most troubling is that if we're in a place where we have maybe a split Congress coming into the election, it's not clear to me what we're going to get for an environment and that's a split Congress could be something we have to be very careful around. I know a lot of folks are worried about a blue sweep, not so worried. I think the market is starting to discount some of that. The idea of less uncertainty with the idea of maybe higher costs, I think starting to be incorporated, it just means, I think that companies will continue their relentless pursuit of profitability through technology and as a result, we're going to end up, I think with maybe a slower job market than we might have anticipated and companies would naturally respond that way if their taxes were higher et cetera. And I think that's mostly a U.S. domestic story. The big multinationals have lots of ways to manage their tax bills. And at the end of the day, there's a lot of headline talk but what really matters is the effective rate. And so the effective rates for U.S. companies have only come down a little bit. It's been a help, but headline tax rate that goes up may not be as big of a dent as much as most people expect.

Mike - Chris, a lot of questions around, now getting into what you do. So well for First Republic, $156 billion of assets under management in our Private Wealth Management Group. How are you advising clients this day? And in other words, I have a dollar, I'm going to give it to you. How are you going to allocate that for me for the next year or five years? And maybe that's two different answers. And if these are unfair, feel free to pass.

Chris - They're so unfair of Mike, just kidding. I think it would go back to the title of our talk today. The idea of a market cycle in a month, some of the most challenging things to navigate in market environments that are this volatile. I mean, the period from the middle of March, the middle of April is and if you close your eyes and didn't even look at your statement, you would have been just fine. And that, that's just a rare thing to say, because the biggest down drop in history, biggest recovery in history, all those kinds of things went on in a very short timeframe. And to your point, we're still in a recession, the two quarters of negative growth. But things have happened so rapidly. I think the big thing that is doing for clients is reassessing. And there's an emotional component to decision making about reassessing what am I doing? Why am I doing this? How does this fit in my overall portfolio? What are my goals? Oh, I need x amount of dollars in two years, how do I get that the safest way possible? That's just a different way of looking at financial markets that are versus being very speculative about them. Robin Hood traders aside, which are making some stocks like Kodak and others, not a recommendation go haywire. We don't engage in the spec of this stuff. I think for clients though that are comfortable thinking long-term in a goal oriented way like I just described, balanced accounts still a lot of sense. I realized that what? You're telling me to buy a 10 year bond at 50 basis points, I get that. But the issue around asset allocation is that you're trying to manage a combination of two things. The first is I have to get a goal, I have to get somewhere. The second is I need to manage the cost of being wrong. What if we're really wrong? Or you as an investor are wrong about deflation? Oh my gosh, bonds would be so valuable then. Nobody's talking about that, but that's not a zero risk in a portfolio. Everybody's worried I think about not having the income. I appreciate that, but there are other ways to generate income in portfolios, lots of dividend paying stocks, prefers, et cetera. I bring that up because in a world where you've seen an explosion of lots of different types of investments, I think you can still achieve your goal, but not give up on principles of allocation. And what I'm finding is lots of clients are, I'm going to sit in cash and wait and by the way, when the market's up another 20%, then they'll finally come in and that's not a great time. Or you know, the combination of cash and maybe just a couple of things that they feel comfortable with. I respect why somebody emotionally will have that but I don't think that's the best financial answer because what you need our view in a time like this is flexibility. You need the ability to sell something, to buy something that fell down, or kind of just manage your own peace of mind through those bonds. By the way, in the period from February, March and April So I bring that up because the advice for us is about commitment to your goals even for a longer term strategy and ensuring that you really have a diversification that helps you get to your goal but manage the cost of being wrong and there's art and science around that.

Mike - Chris, thank you for all this. This is really terrific. Two questions that came through, I could probably handle the first one. How do banks handle low interest rates when it's such a big part of the revenues? And you'll get into the second question here. But really it is difficult for banks in a low interest rate environment. The bigger thing that matters is the spread or the shape of the yield curve. Today, one way to look at that is look at the two year treasury versus the 10 year treasury that we've been talking about. And today the two year treasury, I think is probably 12 basis points. The 10 year treasury, about 55 basis points. So you've got a little bit more than a 40 basis point steepness of the curve, which is not steep. But if you go back to a year ago, you recall we were talking inverted. In fact, the yield curve had inverted, that's not a good situation. Because for banks you lend at higher rates than then you give on deposits and that spreading does drive a lot of the revenues. So it's difficult, but banks are managing. And I do think banks are much stronger today than they were in 2008 when this crisis versus then. Screw more capital, more liquidity, stronger credit portfolios and hopeful to the situation as opposed to the financial crisis we talked about in 2008. The second question, Chris, this is for you. Do you see negative interest rates in the United States on the horizon?

Chris - I personally don't, but I also take some solace and I'll explain it in a second. I'll also take some solace that most of the governors don't either. System isn't really set up to deal with negative rates, very hard in terms of processing and all the clearing and all the other functions. Negative mortgages, the experiments that we've seen in places like Denmark and others didn't work out all that well, there's lots of potential for snafu and documentation errors, et cetera. So the administrative costs associated with negative interest rates are not zero. In fact, they're not even not trivial, they're potentially unknown and maybe quite large in a system as big as ours, number one. Number two, we have a very meaningful fractional banking system. Meaning like banks don't have 100% of the capital cover everything. They cover everything by trying to do good underwriting, good loan management, et cetera. But the reality is, a negative interest from our environment would upset all sorts of other things around the fractional banking system. And in particular kind of who’s, what, to whom, and how do we pay it, et cetera. I think it would also lastly, put a lot of pressure on not just treasuries, but on banks and others to pass those costs along ultimately to their consumers and others. And that's a pretty challenging thing to do if we're already punishing savers enough in terms of behind inflation and taxes. So but I'll anchor my comments mostly back at where Fed policymakers are. They don't want to see it either and they've stated as much in many of their public commentary.

Mike - A lot of questions coming through on how you feel about real estate as an investment and Bitcoin as an investment. I'll give you a preview on the latter unless you have an opinion. But certainly real estate, we had a lot of real estate clients and it is a $16 trillion asset class, at least in the commercial real estate side, not to mention all the single family homes in America plus rental property. So any thoughts on real estate? And if you want to elaborate on Bitcoin, that's fine as well

Chris - Yes, sadly real estate is soon to be a bit harder than it has been in the past. In the past, it was kind of buy anything and it tends to work. Cost the capital, cost of money very low and as long as you can exceed it with some leverage you end up in a decent world. Even for class A properties where cap rates, sorry for the jargon, the rate of return you get on your investment was very low, 2%, 3%, that kind of stuff. They were viewed, I think by many experts in the industry as equivalent of bonds. Well, not really because they don't have the same kind of liquidity. I think where we are today is there's three big trends that we see developing. One is easy to talk about and that's kind of the use of office space over the post COVID world. And I think there have been announcements by a number of firms in the first and second quarter earnings period talking about reassessing, but more importantly, reducing their office space. Yes, some companies have said, "We want everybody to come back to work." I appreciate that but I think many employees and many employers are considering what that might mean and that it doesn't seem a, either cheap nor b, very easy to do. And as a result, kind of the status quo with maybe more percentage of workers working at home than we had historically seems like a meaningful one that should have some effect on office demand. And some of the main areas we think. How it plays out, I think is all down to the specifics, but that's one trend. The second is we'll call it the Amazonification of spending, consumption, et cetera. The idea that logistics warehouses close to airports look super interesting. Yeah, they're expensive but boy, there is a tail end around consumption associated with that particularly if everybody goes back to being in their homes. So there's still something there around it. And the last is some of the biggest shortages we see across the real estate industry are in housing more particularly things like multifamily. And a lot of that is location-based but it is important if we're going to talk about getting the 30% of under 34 year olds that still live in mom and dad's basement, out of the basement and into a place. Multifamily, I think is still one that looks interesting. I mean, risk we're trying to understand is how COVID affects that where you have more people closer together in many instances. So to that end, I think those are some of the big things that we're watching in this space. Doesn't mean other things aren't interesting, but they're more deal specific and I think something that's more targeted, which is how we would look at real estate here in much more active approach and just like they always say, "Location, location, location, it's still the most important piece."

Mike - Definitely. Chris, I want to sort of conclude this here. So let me just take a few thoughts and let you wrap it up and then I'll ask you about your backdrop and that question didn't come up. But e for endurance, it does look like a slow grind up, but at least it feels like it's in the right direction. Q-four maybe positive GDP. Well, 2020, I should say overall, but not great. I think you said,

Chris - Yeah, 2020?

Mike - No, you said negative 5 1/2, but next year four in a quarter, which is positive. But e for endurance. So, just thoughts on your outlook for the next 12 and 24 months from a global and a U.S. perspective.

Chris - Yeah, we just finished our asset allocation meeting today. I can share a little bit at least the high level thoughts. We think about things in a scenario way and the way we're looking at it these days is I think there's a 50% or so probability that this muddle through kind of grind higher popcorn of States going off and the like ultimately is our trajectory. So why wouldn't that probability be higher? Well, because we don't know how policy is going to change. We don't know how the COVID virus is. Particularly, we don't know about immunity. There's just no good data on it. And more importantly, having read way too many studies now in detail and just looked at the statistics behind them, not all of them are meaningful. And I understand why it's very confusing both now and is likely to be for at least several more quarters until we see the vaccine or other data. So we still have a waiting game there, that's part of the low grind story. But I think if you look at the GDP of the country, where it is New York, California and you're looking at kind of weighting the country by GDP and COVID, you put all that together in a big mix, you get to a place where things look like they're kind of topping out in terms of infections and the damage to GDP that's happening from COVID. And if it's topping out, that means the arch bend towards improvement. So that's how we look at it. The other 30%, there's 50% left. 30 would be towards, there are some meaningful downside risks here. I said, there's a lot of debt accumulating, the policy decisions that handle that are super important. We won't know those for another 12 or 14 months or so. But I think our view is that that's going to be a big depressor on growth. It's going to be lower than it otherwise might have been globally. So that's some risks around that. I also think there's a case for upside and it could be really anchored on a vaccine. The fact that the rest of the world is, except for South America, which is in a really difficult spot, particularly Peru. But parts of Europe recovering very nicely by the way. Canada doing well, Mexico actually doing okay. So everywhere else seems to be doing a pretty good job of managing some things and that in a global setting, these improvement in a global way. I think eventually catch up and they create opportunities not just in the U.S. but outside the U.S. The upside case kind of recently the world picking up faster than we did in some ways.

Mike - That's great, Chris. That's faith in the future and the endurance to get there. A lot of questions still out there on certain investment strategies. What I would suggest is a perfect opportunity to reach out to your First Republic wealth advisor. And they are more than capable of sitting down and obviously helping each strategies tailored to the individual. But these are volatile times and we expect that going forward but there's a great opportunity. I guess I'll leave it Chris with a question that came up and I think it suits your backdrop here about the First Republic Founders index, which you have been very involved with, what is that?

Chris - So last year after a lot of work, we launched an index. And the index was anchored on the idea, I think for those that know First Republic, you know, we're led by our founder, James Herbert. And the founders do things differently. We find this in private companies all the time. Founders scramble, they do things differently. They kind of take risks that not everybody else would take, they think long-term, they're not always worried about quarter to quarter. What we found in that research is that founders are in almost every part of the economy. They're in real estate, they're in utilities, and they’re everywhere. And what we thought, really anchored on this kind of work that we did was that there's an opportunity to capture that. So we built an index that did that. It's got hundreds of companies in it. It's pretty well diversified and we think it captures the spirit of founders. And what you see behind me is actually the ticker of the mutual fund that we launched a couple of days ago because you can't buy an index, but you can buy the thing that follows it. So that's what we did.

Mike - Christopher Wolfe, I want to thank you and one of our clients said it best. "Thank you for putting these together. Time well spent." And I couldn't agree with you more. It's always a pleasure. For our clients out there, again, thank you for allowing us and giving us the privilege to serve you. We truly appreciate all that you do for us. And again, wishing you all a great health and endurance. And until next time, thank you for tuning in. Thank you, Chris.

Chris - Yeah, you too. Thank you.

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Definitions

Basis Point (bps) is one one-hundredths of a percentage point.

S&P 500 (Standard & Poor’s 500 Index): A market-capitalization-weighted index of the 500 largest U.S. publicly traded companies. One cannot invest directly in an index.

The First Republic Founders IndexSM is an equal weighted benchmark of publicly traded companies in which the founder or founders are actively involved and a key influence in its strategy. The index was launched on October 7, 2019, by IHS Markit, an independent index administrator.

The Fund’s investment objectives, risks, charges and expenses must be considered carefully before investing. The statutory or summary prospectus contains this and other important information about the investment company, and may be obtained by calling (800) 392-1400, or by visiting this link. Read it carefully before investing.

Investing  involves  risk,  and  principal  loss  is  possible.  Companies  led  by  their  founders  involve  risks  related  to  ownership  and  management  of  the  company,  including  entrenchment  issues  in  which  the  founder  uses  his  or  her  position  in  the  company  to  further  his  or  her  personal  gain  or  ambitions,  which  may  negatively affect shareholders. The Fund is not actively managed and the Fund’s adviser will not sell a security due to current or projected performance of a security, industry or sector, unless that security is removed from the Index or the selling of that security is otherwise required upon a reconstitution of the Index in accordance with the index methodology. The performance of the Fund may diverge from that of the Index and may experience tracking error. The Fund’s investments may be concentrated in an industry or group of industries to the extent the Index is so concentrated which makes it more susceptible to factors adversely affecting issuers within that industry than would a fund investing in a more diversified portfolio of securities. Investing in small- and mid-cap companies involves additional risks such as limited liquidity and greater volatility. The Fund may invest in foreign securities which involves political, economic and currency risks, differences in accounting methods and greater volatility. These risks are greater in emerging markets. The Fund is newly organized with no operating history, and there can be no assurance that the Fund will grow to or maintain an economically viable size, in which case the Trust’s Board of Trustees may determine to liquidate the Fund.

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