First Republic Fall Forum Session 4: Policy, Politics and Prices

First Republic Bank
October 14, 2020

Watch our series of conversations designed to explore the geopolitical landscape, U.S. presidential election implications, and key tax and investment considerations. Brought to you in partnership with Eurasia Group, one of the world’s leading global political risk research and consulting firms.
Learn more about Eurasia Group here.

Session 4 discusses: Market Outlook: Policy, Politics and Prices 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, good afternoon everyone. My name is Mike Selfridge. I am the Chief Banking Officer at First Republic Bank. And I want to thank you so much for joining us again. This is our quarterly update on all things markets. And as always, I'm honored to be joined by Christopher Wolfe who is the Chief Investment Officer of First Republic Investment Management, where he oversees our research and strategy for what is now, as of our earnings call this morning, $168 billion in assets under management. So it's always a pleasure to be here with Chris. He is an influencer on the current states of the markets and the economy. You've seen Chris on numerous television networks and in various publications. So Chris, always a pleasure. I'm going to do my typical Q and A with you, and then we'll open it up to the audience. So in terms of housekeeping, if you have any questions, there's a Q and A button there. We'll get to all those questions as, as quickly as we can. So with that, today's topic is politics, policies and prices. And Chris perfect timing, we've got an election coming up. Before we get into the election, because it certainly has different implications on our U.S. economy. We were here July 30th, the last time you and I did this.

Chris Wolfe- Yes.

Mike - And maybe if I just kind of bucket things into the past, but only the past and to what's transpired since July 30th to today, then we'll go into the future. But the future really to me is November 3rd and then 2021. So Chris, the last time we were here, the S&P was 35, 22, it's up another 8 1/2% oil's stuck at $40 a barrel. And here we are. What's your general assessment as of today?

Chris- So, today is an interesting moment. We're just a couple of weeks in front of the election and that is receiving as much press and hype as I think anything that I can recall in the last 30 plus years of my career, I think that's important. There's a lot of noise for investors to become confused around. It's ramped up markedly since July when we last talked. But I think there's some other things that have developed also, that are probably more important than that. But there's going to be a few things we want people to take away, but one of them is that stimulus trumps politics or beats politics almost all the time in capital markets. And the big things that have changed between July and now, all relate to things that look like stimulus. The Fed has been very aggressive in terms of its programs. Many of them is still are very open-ended. And in fact, they just secure their funding by re-updating their mandates, going into the fourth quarter. That's important. We're now back on track for fiscal stimulus in terms of the Republicans and Democrats, are starting to get that together. So it turns out that when you're in a place where both monetary and fiscal stimulus are pointing in the same direction, markets tend to respond pretty positively. So, while we are kind of new to these, in a flattish space, we've made a meaningful recovery off the bottom in March post COVID. And I think the arc of the economy continues since July, to bend towards reopening with maybe the big caveat that we don't know how the winter season's going to develop. But that arc towards reopening is still in our view, intact.

Mike - Chris, I'm glad you brought up stimulus. And we talked a little bit about this last time, but there's been more since.

Chris - Yeah.

Mike - So, I think global stimulus is now up to about $10 trillion-

Chris - And climbing.

Mike - As a percentage of GDP, and climbing, just to give you a perspective on a couple of the larger economies. So the United States, in the great recession of a wave we used stimulus for about 6% of our GDP. Today, it's about 12%. So nearly double Germany was 3% back in 2008 in the crisis. And now is a third of their GDP. That's stimulus as a percentage of their gross domestic product. Japan back then, 2%, today 21%. And as I mentioned, $10 trillion. So kind of leading us up to today, we are pumping so much money into the global economy. Is that driving this more optimistic view?

Chris - No, I would say as we go into 2021, stimulus is a key feature of why I think markets probably will do okay next year. That's one piece of it. The second piece of it is, I think if you were to close your eyes between now and February, you might actually be in a place where there's a lot of noise and it's not clear that a lot may happen. Politically, I think there will be, but the markets have clearly responded to the stimulus far more than the politics. And I believe that will continue to be the case. Now the other piece of the puzzle is the fundamentals. Markets are pretty far ahead of fundamentals, but the reality is, when things do turn, given the operating leverage in the system, what that really means is for a certain percent of growth in sales, you get a much bigger growth in earnings. What we think will happen is that the earnings numbers could accelerate very strongly next year if you just get a little bit of stabilization in the revenue line, through stimulus, but also through that arc of things opening. So I think markets are starting to suss that out. They're starting to discount that those three things, the stimulus, the arc of improvement, and then the results should be that the earnings numbers turn out to be pretty big. Now we think it's about $165 this year, for the S&P 500, but there could be upside to that, if there is some stabilization and the arc towards reopening actually accelerates a bit.

Mike - So now let's get into politics, with our policies, politics, and prices discussion. We've got a big election, obviously coming up, probably one that will be for the records. You want to talk about the different outcomes and namely, it's a sort of a Biden, a White House win, with a Republican Senate, then maybe a Biden win with a Democratic Senate. And then we can stick with Trump. If you'd like to go there.

Chris - So, its power games now, we're just... Which goes where, and there's a lot going on. So I think if you look at many of the odds makers so predictive is one, there's quite a few others that are available. You can catch them on the internet. One extreme, is what calls blue sweep but a Democrat President, Democrat Senate, and democratic House of Representatives. And in that type of an approach, you get kind of where we were in 2016, 2017, more or less, you get one party controlling everything. And the challenge around that is you tend to make a lot of aggressive moves. That's historically been the case when one party controls everything because it's so infrequent. So when it does happen, boom, a lot of things do happen. Now there's kind of a plus and a minus around that. The plus may be that we see lots of stimulus and there's some talk. It could be as high as 3, $4 trillion. These are gigantic numbers. And so the number's point you made earlier Mike, we would be well on our way to 20% of GDP in the form of stimulus, both monetary and fiscal. So that's important to keep it in mind, by the way, like I said before, when the two arrows fiscal monetary stimulus is a point in the same way, markets tend to respond pretty positively. And I think that's actually part of the story. But the negative side of it is, wow, that's a lot of new debt, like a lot of new debt and needs to be financed. And well in the moment, we may not care so much about it. The bond market probably will. And the bond market will look at that and say, good Lord, the interest rates at the 10-year and 20 and 30-year are probably too low for the mountain of debt that needs to be refinanced. We could see interest rates moving up in that type of environment. The second would be a Democrat President in a split Congress likely that Republicans retain control of the Senate by a narrow margin. In that case, there's probably a bit of gridlock but there are still some changes that would likely happen around that. Like, we'd still get stimulus probably in a smaller package. Number one, number two. We probably reorient some of our tree discussions, certainly with respect to Europe and Japan, much likely we would, in the blue wave. That's probably not so bad for the big multinationals, but in both cases, you may see some changes. Certainly the blue wave to the tax picture, we'll have corporate and personal taxes in a split Congress that may be harder to get through. I think in the last piece where, Mr. Trump retains the presidency and regardless of where the Congress is, you get a lot of the same in terms of where we are, current policy, you get some stimulus, and it's not clear where we're going to go after that because there have not been clearly articulated policy measures. Clearly there are broad conceptual elements discussed and clearly articulated policy measures that are likely to be put in place. I think markets might be challenged around that because a lot of what's been happening lately has been political and policy volatility. The good news should be for markets, that policy certainty is coming one way or another by February of next year. I think that the opportunity is to get from here to there without ruffling your portfolios and creating all sorts of extreme outcomes before we have, I think more information about how things develop.

Mike - I’ll get into the markets as we move into 2021, Chris. But your team has done a little bit of research on, and I think they look back 75 years on changes in the presidency and the influence on the market. It really hasn't made that much of a difference.

Chris - There are some historians that look at the market and try to find correlates between, well, in the third year it does this, in the fourth year, it does that. In the first year of a new regime after your regime this happened. And there's a lot of things that history tells you, but history in the future, they sometimes rhyme, not always perfectly. So, I think we want to have an open mind going into where we're likely headed, and keep the one over overwhelming fact, front and center, a little bit like Occam's razor. The simplest thing is probably the most important thing. It's the stimulus. There's a lot coming and that's going to be the dominant narrative, even so much, and so in front of politics, in our view, going through the next couple of quarters. Now, politics do matter because at the margin, policies around say energy or trade are likely to affect sectors of the market. And that's actually pretty important for investors going forward, particularly after these monster runs that we've seen in technology and healthcare. I have the opportunity anchored on COVID, and businesses looking to keep their operating leverage high.

Mike - So before I get into debts and deficits, and the stock market prices, I'm just kind of your macro picture for the U.S., Gross Domestic Product tailing off this year and then into 2021.

Chris - Yup, so in our view right now, and it's pretty late in the year, so a lot of numbers are starting to get baked, is that we're down somewhere in the mid-single digits for GDP in 2020, there's a rebound next year. But on the rebound, in terms of degree, it could be as low as kind of a 2 to 3% range. And as high as five or six, depends a lot on a couple of things. It depends a lot on the arc of reopening. It depends on the amount of stimulus. It depends on the amount of policy stability that comes through post-election, so that all the cash in the margin that's been building up in the corporate sector, can be redeployed into capital expenditures and reinvestment. So that reinvestment engine once kicked-off could be a powerful accelerator to a business dynamics in the U.S. economy could be a powerful accelerator for job creation. So those things are a little bit dependent on how things work out, but the U.S. economy is a big, hard to disrupt thing. Think about COVID. It took the massive shutdown of a big chunk of the economy to just drive a recession at the annual level of about three, 4%. And I'm not downplaying the job loss, but I am getting to, this is a big country, with a big economy. And it's very hard even with some extreme efforts to just upend everything. There's a lot of natural processes that go on in terms of consumption of goods, services foods, et cetera that are going to continue, regardless. And those things will carry us well into 2021. It's really about where the next set of investments go. And with corporations full of cash, we want them to start putting that cash to work.

Mike - So Chris, the U.S. economy is consumer-driven. We, you and I, and collectively everyone on this call and everyone in the nation contributes to about 70% of the Gross Domestic Product. Confidence, it took a big hit and obviously it did, but it's kind of inched back. And so you look at some of the, maybe the tailwinds, household saving is up. I think somewhere between 12 and 15% year over year. Consumer balance sheets, if you look at household net worth, it's now at an all-time high again. Estimated to be about $121 trillion. Took a hit in COVID, and now it's bounced back, and household income is up 7% year over year. So, what are you sort of thinking as a consumer driving the economy and the growth for the next few years?

Chris - Well, I think about it in the following ways, and the surface and the reported numbers that we see, they're all really good. Higher savings rate as a buffer against shocks. Things like a resumption of income is a kind of key indicator for economic health in some ways. So those are good base level understanding of kind of data that's been reported. But we lift up the covers, we find that those numbers vary greatly by how much you're making. So if you're making a million dollars a year versus making 50,000 a year, you have a wildly different experience. And at 50,000, you may not even have a job. So the challenge here is that the statistics are averages and what's happened is the averages are getting dragged up by the top 1%, half of one top. One 10th of 1% that have had wild acceleration in the stock market based wealth and income effects that they're enjoying. So it's harder to state that this is a broad-based, consumer-based, job-based recovery. In fact the data says that's not the case quite yet. What it is in terms of the job recovery, you've got about half that number one, but a worrying sign is developing. And that is the number of folks with permanent job loss or what they believe are permanent job losses, or long-term job losses continues to remain stubbornly high. So we're not seeing this rehiring trend. When you look at some of the layoff things around, layoff trends around the hospitality, and the transportation, airlines, hotel, industry, they continued. And even at our team, we continue to actually pick off. So there are some challenges around that, and frankly, those represent the strongest case for the call to why we need stimulus in order to ensure that we don't create a raft of unintentional bankruptcies that personal small business, and that the corporate levels, the bigger corporate levels and that we don't prolong a lot of both economic but also social situations that are quite dire in many cases without this data. So I think that there's an opportunity there to see that kind of improvement that frankly for us would raise a lot of confidence about how 2021 turns out. Should we see that broadening, but we're not there yet. And there's a little bit of a Catch-22, and what needs to happen in most Catch-22 is that are economic, the government's got to step in and break. It's got to break it with stimulus.

Mike - I want to drill into that because what you're hitting on is an important aspect. It's not all that rosy, and not all Americans are weathering this pandemic equally. Your team came out with some stats. I think if you're making minimum wage, the unemployment rate is still almost 30% which is just extraordinary. If you don't have a diploma or degree, it's about -18%. So unemployment rate 18%, whereas college graduates almost 0% unemployment, 1% and making more than $20 an hour. I think the unemployment rates probably one or 2%. So it really is a bit of a tale of two cities as it relates to the American population. And while we brought maybe half the jobs back to the 22 million that were lost, maybe just drill in a little bit more on the policies that will take place to help the half of the America that's not weathering the storm so well.

Chris - So I think that's a great point Mike. I mean the letter that folks use actually is letter K, let's get to speed recovery. The folks that are kind of invested in a stock market done extremely well in terms of recovery, but anyone that's not a salary or wage-based worker is experiencing very different recovery in this last six and seven months. I think going forward, a number of things need to happen. The first is the stimulus. The reality is, stimulus is meant to be a stock gap between when and if we get a widespread, widely deployed, and widely used vaccine, that's a ways away. We had originally estimated that somewhere in the middle of 2021, it could be closer to the end. I think the market will treat on the news of the vaccine, certainly and treated reasonably well with the Regeneron data coming from the president's comments. But I think the reality is, getting a widespread vaccine so that we can commune again. Be in the same place at the same time, without masks, without kind of 86 other precautionary measures which are all well and good, but they do get in the way of normal human interactions. And I think humans are adaptable. They've gone through it, but that stimulus is meant to get us to that time period when communing can resume. We're not quite there yet. By the way, it's not just communing, it's transportation to the commuting site, your work or wherever it is. Those are all things that need to happen. Policy-wise, and that's the arc of reopening by the way, a kind of dependent to some degree around the rush that we're seeing in terms of the vaccine deployment. But policies beyond stimulus, importantly we could be looking at and it's possible to consider a jobs growth arc, much like we saw in 2000-2002 periods after Y2K and the tech burst. There are opportunities around that where you can create direct incentives or expand some of the existing programs to create more incentives to just hire people, put them back on the payroll. And I think that's important. Particularly when you're talking about one other piece of the unemployment data, which is folks under 35, also have a very high unemployment rate relative to everybody else. So we found out where the give in the labor market is, it's the unskilled and not college-educated. And those that are under 35 all kind of fall in a big group. And that's the group that has absorbed the most damage in terms of the COVID crisis. That happens to be that a lot of them are employed in the hospitality, transport and other industries. So we need those things to actually come back to some degree as well. And policies that help companies do that keep people employed, are the ones that are needed.

Mike - So Chris, you were referencing a lot of stimulus now, structurally just think of the United States. And I think our national debt is going to be approaching $26 trillion on an economy that probably went from 21 down to 19 trillion or something less than that. Structurally, we earn revenues of 3 trillion and we spend 6 trillion. We've got some nondiscretionary items like Medicare and social security that almost virtually eat up all the revenue. So how long can the U.S. keep taking on more debt, more negative spending before this is a big issue?

Chris - Oh, this is going to sound a little glib but I think Japan is the link here. This can go on as long as policymakers want it to go on. And here's what I mean by that, governments and in particular, you've seen it kind of kick off in Japan, but it's become much more commonplace in the last 15, 20 years. Change rules all the time. They change rules about who can buy what, who can sell what, who can own what, all those kinds of things. Japan did it. We would have never thought that the postal system would go away from bonds and buy Japanese ETFs, yet here we are controlling 80 plus percent of the Japanese ETF market by whom, oh, the government. Wait, what, how did that happen? So the reality is the Feds creativity kind of spurned on by kind of the debt excesses that have already been building up. It's just the latest in the way that governments change rules. Who would've thought that they now have three basically unbound programs, that as long as they're re-certified, have unlimited amounts of capital to go in and do all sorts of interesting things. If you would've asked me 10 years ago, would the Fed buy corporate bonds? Would they buy exchange-traded funds from other people? We'd have said, that's crazy that would take capitalism in a new direction. Yet, here we are, the Fed is doing exactly that, or has been doing that. So I bring this up because the rule changing has meant really kind of the focus on, well, geez, what is the most important thing at least in the intermediate term? And that's the financing of the debt. Because interest rates hover around zero, you can have very large amounts of debt, not consume too much of the overall budget pie, right now it's somewhere a little bit less than 10%, but as it gets bigger, it starts to crowd out other things. That reckoning may come in a couple of years, because by the time you add, see another 4 trillion or 5 trillion in debt. Even with low rates, it starts to add up. And we're talking about a couple hundred billion extra in interest payments. And now it starts to be a meaningful number, relative to everything else that the government's spending on. So how long can it continue? For as long as the government makes the rules that will ultimately allow it to continue. I think it can go on for a while. I think the fallacy is to believe it's all going to come crashing down because there are market forces that will force the gigantic size of the U.S. stock and bond markets. North of 50 trillion, 60 trillion to just obey, like that's not going to happen in Japan, much smaller back in 1990, prove that the government can actually set a lot of the standards here. And I think that's the environment we're in. That's why if you go back to the point about stimulus, Trump's politics, the idea is really simple and straightforward. There's so much stimulus flooding the system that the thing that inflates, at least in the very near term is likely to be asset prices.

Mike - So you, you are familiar with MMT economics, Modern Monetary Theory, which is a... I guess it's called, a header heterodox which means it's not conventional. It doesn't conform to standards. But it essentially supports what you're saying. As long as you are a sovereign nation, and you can print currency, you can sort of print your way out of this and keep increasing deficits and debts.

Chris - Yup, in the seventies and eighties, that was called monetizing the debt. It was deemed a bad thing by political and economic sciences that we are in a place today, with the accumulation of debt, kind of North of 250 trillion globally, that is no longer the case in terms of what's deemed acceptable. So the heterodox aspect and non-traditional aspect of it is that, that there is an opportunity to keep printing and keep going and helping everybody. And there's some linkages that I think some political commentators make to socialism. And I'm going to leave those off the table for a moment, because they're not important for the purposes of this discussion. What is important though, is what's actually underpinning the aspect of MMT and that's something called, seigniorage. And that's really a term of art. It's about, hey, when you have your own money to be available to satisfy your own debts, you can't just print your way out of it. Here's the crux of that seigniorage challenge, why it's worked so well in Japan, but not so well in other places like breeze. It worked well in Japan because Japan loaned most of the money to itself. It turns out we owe a lot of money to ourselves, the United States, not so much as to paying to itself. So it's a little trickier for us. It was an impossibility for Greece back in the Greek debt crisis because Greece habits own currency prints anything and it owed money to everyone else. That's really the challenge around it. So where we are today, a little bit trickier and likely to kind of continue down this path, unless we see a lot of changes, at least around the school policy from Congress but that's unlikely to happen until we clear this COVID situation, which we think is at least until the end of 2021. Last caveat, one, the things that I do think about related to COVID and all the stimulus here, is we've kind of suffered a body blow here, a very hard. I'm not sure how things would work, should there be another one. There'd be another round of stimulus closing. Maybe the lessons learned are you don't close things down. I'm not sure, but to the extent of reminded by a Bill Gates quote, "It's not the missiles that will get us, it's the microbes, it's the " So I bring that up in a lighthearted way and suggest that there's lots of things to be worried about and markets and not sure politics is the first one.

Mike - Yeah, a couple of questions in the Q and A, and they sent her around the virus. You just noted maybe the end of 2021, and that you're thinking sort of a vaccine and distribution of a vaccine.

Chris - Yeah, the vaccine story is an interesting one here. So the President received an experimental dose. Those are following, those of the medical profession, I'm hoping to get all of this right. We've done a lot of study around this. There are a large number of trials with large numbers of patients are just subjects, kind of being set up. Many of them are could have it done the correct way. Double-blind all that type of stuff. So they're likely to produce really good or robust results. Meaning they're meaningful, they're are applicable, et cetera. You're going to next run into some production issues. How quickly can you produce them? Even Remdesivir which the Regeneron, the company that manufactures it said, they're kind of working out the efficacy and the safety are very good. There's some improvements statistically that they were able to prove and they're double-blind tests. They only have several hundred thousand doses. There's 330 million people in this country. I mean, that's a drop in the bucket kind of stuff. So until you get to very large coverage, you're in a place of having to decide who gets what when. And that's not an easy decision, that's a tricky decision. And it's one that's fraught with a lot of peril. So until we get more of these blanket coverage and by the way, it's not just Remdesivir. There's maybe six other things that could all come to bear in the next nine months or so, maybe with different degrees of efficacy, different degrees of safety. And it's not clear how the market will sort all of that out. So there's likely to be a fair bit of confusion during that period. Our sense is that things will probably stabilize a bit in terms of what's being promoted, how it's being taken, what the distribution is, by the time we're in the middle towards the end of next year. But the market will probably trade way before that saying, look, if the vaccines are proved to be efficacious, you can be work and they're safe. They don't harm people while they're doing it. I think the market will be somewhat relieved around that, particularly because that marks a new path, as the path toward a function where we can start commuting again. And there's more clarity around that path with the vaccine.

Mike - Yeah, Chris, a lot of questions around the stock market, before that, I want to talk about interest rates, something obviously near and dear to our hearts at First Republic as a bank. First, the Federal Reserve who has now increased their own balance sheet to, upwards of $7 trillion. And I think you referenced them buying everything from asset backed securities, to corporate debt, which is really unheard of in the past. And so I think it was the late famous investor Marty Zweig who said in 1970, don't fight the Fed. You're going to fight the Fed?

Chris - No, no, no, that's a bad idea. In my investing lifetime, it's always been a bad idea. If you go prior to 70, it was usually a bad idea. And most of the time throughout all of history, and you throw this much stimulus into the system, it's a bad idea. That said, it doesn't mean you should be blindly following in the footsteps of maybe your friends, or a hedge fund or whatever. It is still an opportunity to be thoughtful, to be careful around things like asset allocation, where are you on the equity market? A lot of folks kind of get hung up. This is in terms of investing biases. This is a great time to get caught up in hindsight bias. If I only woulda coulda shoulda invested right after the fall, or confirmation bias. See, because I bought Apple, three months ago and it's up a kajillion percent. It's going to go up a kajillion percent. It's a great time to just strip all those biases away and start fresh. We're in front of an election, it's likely to create a lot of noise and volatility. I think a lot of clients are going to have opportunities to rebalance portfolios in a meaningful way. I expect big moves between here and there because she needs to control some of the markets and they make things worse on the upside and the downside. So part of the reality is now we should expect that between here and say, February, a lot of opportunities to get your tax house in order, to get your investment house in order. And I think many clients, maybe anchored on the recent past, or just really stuck on things like the FAANG, or Facebook, Apple I forget all those kinds of stocks. And that there's an expectation that continue to rise. And when the stimulus is in place that can still work. The reality, I think, is it's a good moment from a position of strength to make some changes in portfolio. This is how I would.

Mike - So, in terms of the Fed view now, I think they've done an incredible job in this whole pandemic, but looking at interest rates, sort of going forward and the Fed has two mandates that full unemployment or full employment, I should say, and price stability which is really centered around inflation. They made a pretty important distinction on inflation recently related to not 2%, but an average of 2% which suggests a number of things. But maybe you could talk a little bit about that and where you think rates are going to be for the next year or two years.

Chris - Yes, I think there's three important messages that are the Fed's actions. The first is that, of their two mandates, full employment and price stability. They're going to let price stability to go for a while. It's really about employment. So making money as cheap as possible, in order to spur employment, is going to be where we want to stay focused. That's going to be the core of their message. The second piece is, by using an average, rather than a spot estimate or some other method, they're actually saying that well, if we look back when inflation was at 1%, but now it's at three, the average is two. But it's at three right now. There's likely to be a lot more consternation in the bond market about how things are today, versus the Fed who would likely be perceived as being behind the curve. And the fed is saying, we're comfortable being behind the curve, because we've got to get this job engine moving. So we're sacrificing not sacrificing. We're putting to this to the slight side, the mandate around price stability, in order to let things run higher. Now here's the third piece which is, to dig into all the data, you find out that the Fed has pretty good reason to do this. There's a concept called, money velocity. And that's how often does a dollar move around in the economy? And over the last 10, 15 years, it's been slowly declining. But post COVID, it collapsed. Meaning a single dollar is no longer moving around the economy, and that new stimulus isn't creating a multiplier effect. So all the money that's kind of shot in the system. It's almost dollar for dollar, rather than a dollar for $2, or a dollar for a dollar 50. We used to get that kind of multiplier through it because money would move quickly. And that makes sense, but you're worried about COVID, and you're saving more money, and more money is tied up in the stock market, is not in any transactions, at least for retail folks, that makes a lot of sense. And you're out of a job. It makes a lot of sense that you don't see money velocity pickups. So inflation may be always away until that story around money velocity picks up and that may be tied to job growth, and ultimately how we see job creation and job stability over the next couple of years. So bottom line here is those messages really argue strongly for the Fed to stand behind the curve, keeping easy money to your point, very low. We had originally thought it was a 2022 thing. It might be 23 or 24 at this point. At least based on what their talk is. So we'll use that as our starting point before we kind of make some estimates around longer term rates.

Mike - So lower for longer, just as we said in July. And that will continue. Let's shift gears to the stock market. Got a lot of questions here on the stock market about whether it's too expensive right now actually, I opened with the remarks of how much the S&P has increased just since we were here in July, a year to day, S&P is up 18%, NASDAQ's up 32%. And if you look at the price earnings multiple, it's a way to value the stock market and individual stocks. The 20-year average for the S&P, is I think about 17 and a half price earnings multiple. Today, I think we're pushing 24, 25. What are your thoughts on the valuation of the stock market overall?

Chris - Yeah, I think that some of those return numbers, some of those might be the six month numbers make it a thing, but huge off the bottom, but you make a great point, is the market prices are way ahead of the fundamentals, the EPS numbers. There's many metrics we use. Price earnings per share, a whole bunch of other kind of acronyms, which I'm happy to describe. None of them say cheap. None of them scream cheap. None of them even get to fair value. Most of them are really extended but there's kind of a reason for that. And it's really simply, its stimulus. Stimulus here is all in anticipation of a whole chain of interesting things, maybe good things that are likely to happen. A lot of stimulus can stave off bankruptcy. It probably keeps credit spreads lower than some market human gloomers we're anticipating, lower credit spreads means companies can finance. Either sell finance or secure loans. They can actually go back to hiring. So you can see, for example, just with those three simple links, that the stimulus story which helps anchor that hey, reduction in risk mean through a bankruptcy, but also a little bit of encouragement in terms of spending and revenue growth. With that high degree of operating leverage. it's kind of $1 of sales growth gets to, one percentage of sales growth gets you to one and a half to two percentage growth in earnings per share. So there's likely to be some acceleration around that. Our view is we're going to see at least $165 this year in earnings in S&P 500. There's upside potentially to that number next year. Maybe as high as 190, we'll care for putting that out there at this point. But the reality is, there's just so much gearing in corporate cost structures and they're likely to lag in their hiring. It's probably going to be a slow and bumpy ride in terms of hiring, which means as revenues increase just a little bit from two to even 3%, you can start to put up a really good earnings numbers and you'll just be really slow on hiring. Those two things, operating, leveraging, and slow hiring means that the earnings numbers have some upside. Now there are some things can upend the Apple cart. Some big policy changes we haven't considered yet, a whole raft of instability. Maybe there's an entire balloon of COVID over the winter that we just don't understand yet. Indications aren't there yet. But there's a lot of things that really, I think for us, frame that there's a fundamental story that needs to catch up here, but there are still some meaningful risks.

Mike - Chris, the thought of a lot of sort of pent-up liquidity and low rates for long, and you use an acronym called ANGI, but money is chasing yield. There's no yield at say a bank. In terms of savings, where do you see sort of the flows of capital that people are in search of yield?

Chris - So the interesting thing, I think about all of that, is that the flows, the capital searching for yield have in large measure gone back to the equity market, because the biggest buyers of fixed income these days are the banks. We do see clients, focus to some degree there. Although if we're a blue sweep, you need to probably still look really good, even at 1%. So I wouldn't be afraid of looking at kind of monies in their traditional role, or even treasuries as a bulwark against other volatility, and as a tool for liquidity that do think that there'll be relatively liquid. State finances being pretty good also, helps that any kind of stimulus that helps stay finances makes monies even more attractive. So I think we're in a decent place there. I think the story around a kind of Fed lower for longer, where to look for income, is really been around for maybe the last five, six years as the Fed has kind of squashing interest rates. It's been around longer 10 years, 11 years now in Europe. And what we've seen as a response by clients, which I think is well warranted to just diversify the sources of income. Find it from different places. Prefer to closed end funds, or alternative sources in the private markets. There's lots of credit available that has been disintermediating parts of the banking system. It's higher risk credit, but you get paid 6, 8, 10%, assuming you're qualified and all that. But I think the opportunity set for most clients is to look beyond the traditional. Traditional still serves a purpose, it's liquidity based and it really gives you the rebalancing function that you need. But I think the alternative sources are really an opportunity to think about two things. How do I get my income, and from what sources? And second, how risky is it relative to my stocks? And in some cases you might have to reduce your stocks a little bit, to buy these other income generators. And that's an important dynamic that we don't know. I don't know that enough clients have considered, is reducing some of the stocks to buy some of the riskier income, because you want to keep the total portfolio risk in line. And what we're finding is, nope keep my stocks where they are. That's the hindsight bias because it went up, and confirmation bias, I will keep with it. And then I'm just going to buy riskier, fixed income. In fact, what they did, is in that chasing behavior, you just have it all the way riskier portfolio you started with. And I'm fairly confident that that's the kind of place where if you're not paying attention, or you're not kind of working with your wealth manager, and anchored on what your real risk tolerance is, you can really get off sides. And that's why I said, it's a really good moment after kind of a big recovery, a position of strength to reassess where you are.

Mike - I like the comment of working with your First Republic Wealth Advisor to... Obviously there's so much going on, a lot of volatility, a lot of uncertainty, but how are you kind of positioning the investment management portfolio today? And I don't know, if you're... Are you thinking differently as the one election result versus the other? Are you thinking a little more long-term and diversifying?

Chris - So like, the best defense in many cases is the good offense. The way I mean that, is a good offense is a well balanced portfolio. Because what you need in times of turbulence, and always is flexibility. Like one of those MasterCard commercials. So they take, hey, a camera's $7, fill in $2, memory's priceless kind of thing. It becomes stocks, fine, whatever, $3,000 bonds, $100, flexibility when you need it when there's volatility priceless, then you know, the reality is that the markets have done a pretty good job concentrating portfolios in tech, and healthcare and investors have kind of done the same by saying, oh, let's sell these losers, take the tax loss and buy the winners. And that's understandable. But I think now is that moment to kind of look at where a balanced portfolio can be very helpful. Longer term, I think not just getting through this through short period, I think the bigger trends really anchor in three parts. The first is, the amount of government interventions stimulus, et cetera, has got a long pale to it. It's going to be with us for the next several years. That's probably got some support function for markets here in the intermediate term, number one. Number two is digital everything, everything digital. From medicine, healthcare everywhere. It has accelerated wildly in what we're finding in talking with a company C-suite. They want to put the next dollar into digital investments. It's a huge payoff. It's a fixed cost or very low maintenance. And it doesn't cost the same as putting a person in place. So, it's good for corporations, not so good for other things. Now, the reality is that the profit functions likely to, in the margin function is likely to be sustained out of all of that. And that's really a case where equities, ultimately out of this environment. The last piece, which I think is the one you've referenced globally which is, we've been through a long period where a stay-at-home strategy works the best. And now it's a couple of strategy points that are inequities around that. We recently started to dip our toes back into Europe and Japan, recommending that wealth managers have that conversation with clients about look, there's a lot of cheaper stuff there. There's is just as much operating leverage and boy, they're running with bigger stimulus than we are. And yes, the COVID was a lot better in Solveria recently. It started to pick up. But I think our views that Europe has responded to the initial COVID crisis in a very direct way, in a way that contained things. And yes, it's very hard to stamp out, but the reality is they're dealing with it in a certain way, that's very different than our kind of multi-state patchwork Mosaic approach. It's very challenging, I think. Here's where I go with that. If things stay as they are, and I'm talking about kind of the election outcomes, I think we're in a place where there's a combination of factors whether it's improvements with relations in Europe and Japan, the operating leverage and cheaper valuations, and the U.S. markets kind of being in their current state. So just money could be moving a little bit more outside than U.S. I feel a little bit more comfortable with that, with a bit of evaluation support. I think the big challenge to that view, would be President Trump were reelected and we had a Republican Congress. I'd expect a lot more of the trade issues to be front and center, and we might have to go right back to the stay-home strategy. Because even though the dollar would likely still be weak in that environment. I think multinationals will find it a much harder way to compete and be pretty challenging. And we'd probably want to stay focused on U.S. markets. Where the stimulus likely to continue increasing and where our response function that arc opening is actually a little bit more advanced than some of the other countries. So a little bit does depend on the election, but those are tactical shifts rather than big strategy piece here. There's been a permanent change in my view, in margin story in the U.S. companies. And that's permanent, I should be careful. Never say never, and always, never say always right? The reality is I think there's been a structural shift in the way the margins in U.S. companies are likely to work in the next several years, if not decades, because it's all about the deployment of technology and each increment of technology helps preserve margin. So that means only for a little bit more in sales, you can still get that much more in EPS. And that tends to be pretty good for earnings acceleration and poor valuations in the U.S. market. So, that balance strategy still works. I think that's really the core here. Last piece that I'm drawing in a bit, one of the biggest opportunities continues to be around the alternative space. That's private markets, and for clients that can do this, tying up some of their money in liquid investments. A lot of it has to do with the way bank rules have made it a little bit more challenging to lend in complex and difficult situations. They have to hold more capital banks do, but a hedge fund doesn't, private equity shop doesn't, now that makes them riskier. You've got to get paid for it. But those looking for yield, part of that diversification story, I think has to look increasingly towards some of the private markets where little bits there can help be meaningful diversifiers without sacrificing too much

Mike - Chris, piecing together a few questions in the Q and A room here on China, just the continued tensions between the United States and China, the trade wars, and also a question about what if they cut their large holdings of a U.S. treasury. So maybe some overall thoughts on China in this situation that we're in, might that change depending on the elections?

Chris - Unlikely to change in the very near term, neither Trump nor Biden have indicated that they want to change their stance on intellectual property theft and kind of the way cyber relations work between the countries. So, I would anticipate that will largely remain like this. I think a form of economic warfare involving China selling all of its, or liquidating all of its U.S. treasuries is just not on the table. It's not even in the cars at the moment. There's surely plus, a little less than a trillion. That's a large amount of capital. Something that extreme, would probably elicit an extreme response from the U.S., don't know if it's military, but at least from an economic standpoint, I imagined around the table, and the treasury and in federal markets open. Federal open market community they'd be talking about the golden coin. Mint to coin worth a trillion dollars and put it in the treasury, and say, well, geez, this is our debt issue solved. So I'm being a little glib here, but that's an extreme anticipation. China has been reducing their holdings of the U.S. treasuries, but it's been picked up by Japan to a lesser extent by a kind of Middle East, et cetera. So to the extent that China reduces in their other buyers, we're largely okay. And what the Fed has indicated that they're likely to be a big buyer as well. With some of their programs unlimited, and banks actually starting to pick up profitability, I think folks on the call may know they're also likely to be buyers. So we're trying to likely do that. I think it's relatively low, and there are some foreign policy experts that are talking about how that might be considered, should the President win re-election. But I think that's a long shot relative to all the other economic damage that would be done to China's trust banks, its own financial system, and the foreign currency markets, which without getting into the weeds, are actually quite challenging for China. They've been using some of their foreign reserves, in order to defend their currency or at least knock it down. It's actually been quite strong recently as the Chinese market's done so well. And that's a problem for them because they need a weaker currency and exports to help manage their own economy. And that's a challenge.

Mike - Chris, lastly, just going to wrap it up here, your thoughts on what are you optimistic about for the next 12 months, and what are the tailwinds that are concerning you?

Chris - So headwinds, tailwinds. So let's do the tailwinds, a reason to be optimistic, I think it's the stimulus. I think between here and February, we're likely to have a lot more confidence and certainty around all sorts of things. One way or another markets, tend to reward confidence and certainty relatively well. I'm a big fan of innovation, necessity kind of the mother of innovation and invention. There's all sorts of design labs all over the country these days, cost of money is relatively low and kind of being distributed everywhere. I anticipate that we're going to see a lot of innovations coming forward. There's some interesting ones going on, tele-health for example. There may be kind of good and bad around all that, but the reality is innovation is just I think, an untold or an under told story, outside of the Silicon Valley, and parts of 128 and a Silicon Alley in New York, it's starting to percolate through a lot of different systems. So I'm really encouraged by a lot of those things. I'm also encouraged by the fact that the U.S., despite all the challenges, I think we'll get through the election. But I'm encouraged by the fact that we're in a place for those that are old enough to remember, that doesn't look a lot like the sixties. The sixties were far more torturous and filled with a lot more social torment than where we are today. Now that's by no means saying that today is great. That's not what I was saying. I'm getting to a place where the social effects actually started to overwhelm markets in certain parts of the late sixties. And by the time you got a lot of the policy changes in 68, taking effect in 69, the market did have a hairball. It was down a lot in 69. By the way, Warren Buffet almost went bankrupt during that period. Why do I bring that up? Mostly because yes, when things do spill over, they will affect policies. So I'm shifting to the headwinds right now. I don't see us at that place yet, and I'm encouraged that we haven't gotten to that place. It's been more localized. I am a little concerned about how the election days turn out, but I think with a lot of early voting, there's 11 and a half, almost 1200 ballots already cast, we're well on our way to having a much more representative democracy at this point, that's an encouraging sign. The other the other headwinds I think that are a bit challenging, is digesting all the debt depending on how the election works out. Republicans, if they're in the Senate and there's a Democrat President, a Democrat house could use all the debt as a cudgel to start, saying we need lots of cuts. I don't know, but I think the reality is that the headwinds around the politics aren't zero, we're going to have to watch them carefully. On the business side, I think the headwinds are that Catch-22, and the policy to create jobs. It's actually a very hard one to get through Congress. Why are we giving companies incentives to hire? And we're not quite at that place just yet. We're all about just kind of big blanket numbers which makes a lot of sense, but more targeted to U.S., or more targeted programs, or the acceleration of existing programs is going to be necessary in 2021, and potentially beyond to help propel the economy and keep it in a relatively good pudding. That's important because it requires cooperation. That divided government is very unlikely to cooperate around something like that. You'll get the least acceptable answer to both sides. And that may be the least acceptable and the answer to the economy. That's a headwind, is that kind of political piece of it. Last is, I think the opportunity I think for most investors here, it comes down to things like, confidence and ultimately what they're seeing in the markets. The reason it's a headwind is because I think investors looking at the politics are kind of, oh gosh, it's a big issue. How do I face it? It's the property in Cleveland and this and that. And it's easy to be overwhelmed. And I think I'd remind most investors that have been fully invested in this environment. You're in a position of strength. It's a great opportunity to act, act in a way to comes towards, through with your goals, or through your wealth manager. And despite some of these headwinds, whether they're politically-driven, whether they're kind of market dynamic and debt and crowding-out driven. There are still lots of opportunities, both in public and private markets. Part of our job is to help you find them.

Mike - Great, Chris, I want to, as always, thank you, your insights are invaluable. Your perspective on the market. Really a pleasure to be able to host this with you. I want to thank you for your backdrop there, Chris National Hispanic Heritage Month. That's a great touch, and we appreciate it. To the First Republic clients that are joining us. Thank you so much for your time. And again, if you have any questions, reach out to your First Republic Wealth Advisor. We can connect you with Chris. He does a great weekly update, and his team has a lot of incredible research as it relates to the things that we've discussed. With that, enjoy the rest of the week. Thank you, Chris.

Chris - Thank you, Mike. Thank you everybody.

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