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Market Outlook Beyond 2020: Recovery in Sight

First Republic Bank
December 11, 2020

Watch a 2021 market outlook featuring 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. Thank you for joining us again for our quarterly update on the markets. And my name is Mike Selfridge. I'm the Chief Banking Officer at First Republic Bank, and I'm always delighted to be able to moderate this economic update with Christopher Wolf, who is our Chief Investment Officer for First Republic Investment Management. Chris oversees the research and strategy for our investment management group, which is $168 billion in assets under management. Chris is an influencer in the world of economics and money management. You might have seen him on numerous television shows and also in various periodicals. So Christopher, always a pleasure to be here, and I'm gonna get right into this, as it relates to the last time we've been here, we did this, you and I, in early October. And what a couple of months it's been in terms of a few developments, some good, some bad. I'll let you pick, but if you think about it, I feel like every time we get together, the S&P is up 7%, and the NASDAQ's up 8% every few months. So the markets continue to march forward on a pretty robust path. We've now had a conclusive result with the presidential elections. We've had three vaccines approved, and are starting to be distributed worldwide. And of course this in the midst today of a pretty significant increase in the number of cases and unfortunately fatalities of COVID. So some interesting developments that have happened, but Chris, maybe we'll just start, let's start from an economic and investment perspective on 2020, kind of get your thoughts and then we'll move forward to 2021.

Christopher Wolfe - Wow, 2020 has been a wild ride to say the least. We were having this conversation at the end of March. It would have been all doom and gloom by the end of June. It was, oh my gosh, how quickly did this come back in the markets? And Mike has even indicated just in the last several months, that trend has continued. So doom and gloom and volatility were part of the early days of 2020. With the second half of 2020, if you really think about it a year in two halves has been really driven by a stimulus and the response to the COVID virus, I meant stimulus, both a combination of fiscal, meaning government checks et cetera, PPP, the paycheck protection program as well as monetary stimulus. Lowering interest rates and expanding creativity of the fed. It's just been amazing. A large number of programs this year has helped to set the markets, which are a discounting mechanism. And looking at the idea that interest rates are gonna be a lot lower for a lot longer, and that there's likely to be a lot of money flowing through the system, which there is, have responded accordingly. They've just responded in a Pavlovian way, pretty much directly to all that stimulus. Now, along the way, some other things have happened. We had an election in November, and there's a lot of concern, I think, for markets and participants in September and October as we were highlighting, and things have largely turned out at least with respect to political volatility along the lines we discussed. The markets, however, have ignored that. They've ignored it because the stimulus is washing over everything. And it is influencing ultimately the way that we think markets are behaving. Now that's gonna come to an end somewhere next year, but between here and there, there's likely to be some meaningful changes around, see the earnings picture, the long-term driver of growth, which we'll get into later.

Mike - Let's do that. Let's talk a little bit about stimulus, and I failed to mention to our clients out there. If you have questions, I see some of them are stacking up, go to the Q&A button on your Zoom screen. Go ahead and submit those. And I'll get to those after a few minutes of discussion with Chris here. Chris the way you described that, it's almost, is it artificial? In other words, the stimulus, you talk about it. Look at the central banks balance sheets globally. I think they've gone from something like 15 trillion on central bank balance sheets to 23, to $25 trillion. I mean, these are massive, massive money flows going onto the central bank balance sheets, incredible stimulus going on. So it is this an artificial prop up of asset values?

Chris - I think there's a little bit of truth to that rumor, but I think the bigger story around markets and valuation levels at this point is anchored on two things. The first is, the world's washing a lot of excess capacity. So the inflation story globally is likely to be pretty low for a longer period of time. That gives central banks room to act. And frankly, part of the job of central banks is to act as a shock absorber when things get really bad. That's part of their job. It's not in their mandate with a very express way, but that's how they have reacted historically. And you can think going back 11 years ago, to the European Central Bank, following in the footsteps of what the Japanese Central Banks' did in the 90s and saying, we're gonna draw a line, and say, we're here to be that shock absorber. The creativity of the fed is just the latest in a series of central banks doing that. But I think the second piece of the puzzle is that the world has changed to some degree. There are some good fundamental underpinnings for what's going on in markets these days. And without getting into all the jargon, it turns out that companies these days are more geared. They're more leveraged to the idea that they just need a little bit of growth in order to generate a lot of earnings. That's called operating leverage, but it means that the profit story potentially for 2021, if the arc of reopening follows the vaccine track, which we think it will, by mid-year, you're starting to get to a place where you could see some very meaningful acceleration in earnings per share growth for markets, and that transition to stimulus, artificial, to fundamental, real, using those terms loosely, is what we expect to happen in 2021. So markets, to finish the point, we'll tend to look through things that they think are temporary. They visit the markets, have a mind, sometimes they don't. But to the extent that we're in this period where the expectation of markets and investors is that the vaccine and the COVID situation is likely to resolve itself in a way that is more favorable towards reopening in 2021. And we agree with that view.

Mike - It's hot off the press today. You saw the house took a bit of a one week reprieve. Congress has had difficulty in passing a new stimulus bill. What are the ramifications if everything we're talking about is dependent upon stimulus?

Chris - Well, a lot of things are dependent on stimulus, not everything, but a lot. The story here around stimulus is that there's a meaningful proportion of the economy. The services part of the economy, for example, of which hospitality, hotels, cruise lines, all those kinds of restaurants, et cetera are all part of that. That's the part of the economy that has been under the most pressure. And that pressure point has resulted in a terrible GDP, gross domestic product print in the early part of this year. As it rebounded pretty quickly, we saw a revival, but the durability of that growth is really what we need to think about. And the stimulus from the government is meant to be one of the two bridges we think that 2021 needs to see. We call 2021 a year of two bridges. The first is a healthcare bridge. We gotta get the vaccine. So we get to the middle of the year or beyond with more folks feeling very comfortable commuting. That's what the service industry is based on. The second piece is fiscal monetary stimulus to ensure that we don't suffer between here and there a raft of bankruptcies that would further impair sentiment or overall growth, or even parts of the financial system. So the idea here is those two bridges will help markets, help investors, we think, help the economy get to a better place by the second half of 2021.

Mike - Let's assume Congress does pass the stimulus bill by year end. We've still got maybe upwards of 19 million Americans that are dependent on some form of unemployment benefit. So we'll get into some of the headwinds as it relates to the labor market, but assuming a stimulus bill does pass, your thoughts in general from the macro US perspective on 2021 gross domestic product and how things generally look.

Chris - Yeah, the things generally look like they have looked in a 2016, '17, '18 time period GDP and let's call it the two, two and a half. Maybe there's an upside shot at 3% going into 2021. A lot will depend on how quickly vaccines are deployed and how quickly the broad population gets them. The order of priority for vaccine deployment for most states, is gonna be things like healthcare workers, elderly and a few other priority groups, which is important. Then the mass population typically won't see vaccines until the middle of next year. And frankly from an economic perspective, a GDP perspective, that's the group which are the suspenders that need the vaccine. So that's why we're being a little bit more thoughtful about, it's the middle of year before we start to see a lot more sustainability in the improving trend in GDP. Now that said, in the very short term, it's been influenced by government spending that's helped GDP. We've seen a lot of return to home. Home prices in suburban markets have gone haywire. You see the home improvement companies and people loans and all that kind of stuff do very well. And spending on durable goods has accelerated wildly, things like dishwashers and whatnot. So that's actually a trend that we think will carry well into the first part of 2021 that'll help support GDP. But the real trick here is to see the services sector come back in a reasonable way, a measured way by the second half of 2021. So that's gonna be the key, that bridge that we were talking... The bridges we were talking about have to get us to that place where we can get back to commuting to a degree, and the services industry can come back contributing to GDP growth. That's what a lot depend on.

Mike - What are your thoughts on, as you look forward again to 2021, you're building out portfolios and investments in equities, in fixed income, in the alternatives, how are you positioning things? And I would really want to get into equities. And whether you think they're overvalued, fairly valued, undervalued looking forward. And that's a trick question, Chris. I apologize, but we wanna get your views.

Chris - All of the above. I think the broad positioning message we've been trying to emphasize with clients centers on three things. The first is, reopening should reaccelerate by 2021 going into that period. So for those hiding in the safest investments, that time has passed, the market has already started to adjust, and look ahead. You've seen, for example, small cap companies rally 20 something percent in just a very short timeframe really on the expectation that a combination of vaccine and stimulus will continue to propel the economy forward and make the chances of a recession in 2021 very little, that's our view. And so from that perspective, I think positioning should be for maximum flexibility. There's still likely to be some political jolts here and there. There's that ceiling issue that will come up in the middle of next year, for example. And there's likely to be some policy discussions depending on how the senate races in Georgia turnout in January that could set the stage for how we think about whether the US is more favored or non-US markets might be more favored. So those questions still remain to be answered, but right now, maximum flexibility. And what that means is, don't be sitting around in cash. There are interesting opportunities in the bond market. Spreads continue to come in, and if taxes do change, maybe still look interesting even at these levels in a lot of cases. Beyond that, the equity story, to your point looks a little bit better. That term I used earlier, operating leverage. It's how much for a percentage of sales growth do you get as earnings growth? It's usually a multiplier. And what you're starting to see is that there's a lot of sell side research analysts that are chasing companies who keep revising up their workers, why? Because of the vaccine and because of the stimulus. So our expectation is that there is room to go on earnings estimates potentially to the upside in 2021 that will help propel markets a bit higher. But the second piece of that message is really around rebalancing. A lot of the height and safe dividend stock trade that I think investors went through in 2020 is likely to evolve more towards, Hey, where are the things that have been hardest hit? And that's the last message. You've seen markets, outside the US, particularly Europe because of the massive lockdowns, but you've seen smaller companies in the US and mid cap companies, the areas that have been hardest hit are the ones that are making a comeback. The potential for that to be durable into 2021 is where we want clients to be thinking there are a set of opportunities. Last piece is on alternatives. The idea that qualified and looking for things in their private investing space, that's still looks pretty ripe. Everything from distressed credit investing, cause there'll be a lot of that in 2021, all the way to dramatic technology driven investments, as well as industrial level restructuring and some permanent changes associated with what COVID has done to the economy, looks set to be pretty interesting trends in 2021.

Mike - Yeah, it's interesting timing to say that, and you've got to saying, Chris, called the great paradox, and it's actually a chart that you talk about, which is the contribution of gross domestic product of a category and the market capitalization of such category. So if I recall, one of your talking points from the past has been if you look at areas like technology, media, telecom, of the S&P 500 market cap, that's almost a third. And yet the contribution to gross domestic product for the United States is less than 10%. I'd love to hear your sense of just the amount of money that's going into tech. And here we are two days into two very large IPO's DoorDash and Airbnb. DoorDash was up 86% in its first day of trading. Airbnb was today, it's up 117%, after already taking their issuance range and upping that. So it just seems to be a massive amount of capital seeking, maybe a few of these opportunities in tech, and maybe just talk a little bit about what's happening behind the scenes there.

Chris - So there's actually a lot. And let me boil it down to just a couple of things that I think are important. One is interest rates are very low. There's not a lot of other opportunities. We use a framework called ANGEY, alternatives not good enough yet. So stocks still likely, there are compelling opportunity relative to bonds and relative to cash which doesn't pay you that much. That's what the fed would call operation twist, push people further out on the risk curve buying equities, rather than saving. 'Cause it's very difficult to save and it will remain so. So the second part of, I think the story, that you're getting at is if there's not a lot of alternatives, but the places where there are fast growth, right? The thing that's hardest come by. The thing that scares us in markets is growth at this time. And where is there fast growth? Some of the places that you just mentioned, and in particular, in technology, as the the world just continues to revolve around going from 4G to 5G. we're going from regular reality to augmented reality and virtual reality. We're going in so many directions that require massive uses of technology, that those kinds of investments we think are set to continue. Now, the other piece of that puzzle is that when you think about where all the money's coming from, it's not only relative to other asset classes, it's from the private markets. It's from just some of the big names already in the market. Remember, big stocks like Amazon and Facebook and others traded very large prices. You only have to sell a couple shares of those things to buy some of these other stocks. So when we talk about inside the market, there's likely to be some rotation, maybe towards those higher growth things, but also towards some of the names that have been beaten down. I'd expect some of that to go on. Let me circle back to the first part of your your point there, Mike, the idea then that some of these names like, like Airbnb and others there's just been a real dearth of huge growth opportunities out there. And when you look at the ones that have done well, Apple, Facebook, Alphabet, all those kinds of things, everybody knows those stories pretty well. So these new hot IPO's, it makes sense to some degree, these unicorn IPOs that we would see in a world of low rates, not a lot of other monster growth opportunities that some of these things get bid up in a bit of a frenzy way.

Mike - That's interesting, Chris, a great perspective. I wanna switch gears. I'll go to the labor market now, and which I think maybe in your opinion I'd be curious if it's still a bit of a headwind then we'll talk about interest rates. But if you look at the labor market, at the print level, the unemployment rate went down to 6.7%. But the challenge with that is, it's because a lot of people dropped out of the workforce. So it wasn't really encouraging. And I think numbers just came out that showed the jobless claims up far more than estimated. One of the measures you look at is what's called U-6, which includes discouraged workers looking for jobs and people that have lost full-time jobs and become part-time jobs. And I think, correct me if I'm wrong, the unemployment rate for the U-6 is 12%. That's not a good number. So what kind of headwinds do we face at the labor level? And what do we need to think about as it relates to the economy looking forward?

Chris - Well, as you mentioned at the outset, Mike, the idea that there's 19, 20 million or so workers unemployed, there's pandemic, unemployment claims, there's special emergency unemployment claims, then there's, as you mentioned, the U-6 the unemployment claims that are regular. And then there's the folks that are just underemployed. There is a large proportion of people. So 20 million out of 150 million workforce, that's a pretty big number. To the extent, those folks are mostly in the service industries that I was talking about earlier. It's gonna be crucial that we have a vaccine and that we have a high degree of testing and that we have really that health bridge working well because almost all of those industries require communing, people getting together, one way or another or being in small spaces together. And it's very difficult for those industries to recover any meaningful way without some of the things that we just talked about. So they're going to lag as long as we have haphazard policy, state driven divergences, some states open, some not. We won't have things in a unified way. That may be okay, but what matters for the economy are some of the biggest areas, say LA County or New York City, or parts of Texas. Are they the ones that are actually working on plans to restore some of the reopenings in a meaningfully structured way. So there's some good examples in other countries in Europe, Korea, for example, on how they do testing, tracing, and in outdoor settings, they wear masks. To the extent, we have a patchwork process around the country, we think it's gonna be relatively hard to see a meaningful straight-line acceleration in those things really before the middle of the day.

Mike - Yeah, Chris, and I'm gonna start getting to some audience Q&A stacking up. But before I do that, I wanna talk about interest rates. And you mentioned ANGIE, which seems to be driven by low rates. It would appear that the fed is gonna be accommodated, meaning they're going to keep rates low for at least 2021, if not longer. The yield curve, we talked about a little bit last time, it's actually steepened. So short-term rates are low, longer term rates, if you look at something like the ten-year treasury has risen to a little over 90 basis points. I'd love to get your perspective on what the bond market is saying there. And then just that a global macro. There's still a lot of negative sovereign debt, negative yielding sovereign debt out there. I think to the tune of about $17 trillion. Countries like Germany that has tenure boomed at about negative 60 basis points, Japan, five-year negative, France, ten-year negative. So maybe just a little bit of rate forecasting thoughts on the yield curve, and then what are the bigger issues as it relates to that negative yielding debt that's out there in the world.

Chris - That's a really good question. And I think the simple answer is no one really knows, but I do think we can observe a couple of things that are worth hearing. The first is that it seems clear based on the actions governments around the world are taking that deficits, and specifically the growth of debt, are now becoming more of a political question rather than a financing and economic question. And the reason behind that is because a lot of this debt now carries very low interest rates. It's easy to finance. And to make an absurd example, if interest rates were zero, and your debt wasn't due for 30 years, you can go for a pretty long time without worrying about things. Now you're supposed to amortize like pay things down. But the reality is most countries have something called senior rates. They can print their own money to pay their own debts. So why would these things be important? Because if the political winds are changing, the will is changing to manage debt and deficits, then they may be more permanent features of the landscape for the foreseeable future. In fact, the next several years, if not longer, and as long as inflation remains relatively low, back to our point that there's excesses of a lot of things globally, you're likely to see this accommodation through central banks that keep interest rates low and politicians that say, we need more money, more stimulus, because the cost of this right now is relatively low. The one thing that I would say is the caveat is something called crowding out. The idea that interest payments, even if rates are low, but as long as they're not zero, start to consume bigger and bigger pieces of federal budgets around the world. They become a factor that might shift the decision-making or the politics around what's important over the course of the next several years. So, there is a cost to the debt and deficits, but it's likely to be a political cost first. And after that, I think, it's likely to end up being a a political tool, not just a cost about what choices, but a tool for parties around the world to frame how they wanna address debt and deficits as we get through this period.

Mike - Chris, we had a question come in from a client here. And as I mentioned earlier, we've now got certainty in terms of the presidential election. We're still waiting to see what happens in Georgia as it relates to the Senate. We know the house could be blue. So maybe just some thoughts on tax legislation in different scenarios of red Senate, blue Senate, and how that might impact certain areas of economic... What economic implications that might have for the United States.

Chris - So it's really two things, but there's a lot of subtlety to it. So the two big things are taxes and trade. So Mike, as you mentioned, the idea that with a Senate that would be 50-50, which is what the elections in Georgia could reveal. 50 Democrat, 50 Republican, in which case the tiebreaker would be the vice-president elect, or Vice President Kamala Harris. So to the extent, that represents a, even if Democrats are elected, it still represents a meaningful divide. I mean, 50-50 split is something that, it doesn't represent political will, doesn't represent mandates. And given the divisiveness of all the politics in the country recently, I think it would be who've president or president elect to tread carefully around that and be careful of wielding a big cuddle. And that's not a political statement, because we've seen the cost of swinging pendulums, one way or another, policy instability changes the way we need to think about investing, it's just a simple rubric. I think that the outcome though, should we see a Democrat Senate, is we're likely to get some treats that are easier to understand, I'm sorry, some changes in policy that are easier understand on trade, less so on taxation. I think it will be much harder to change a lot of the taxation rules. That said, the things that, I think our clients would care about are whether or not there's everything from step up in basis to how is our general partnerships taxed. Also to how how you think about corporate taxation. And that's probably the biggest one around that. I think the brutal reality is that corporate taxation is a sticky wicket. The tax code is thousands of pages long, and that even major changes to the tax code still leave large loopholes.

And as we've seen from many data points, both on the right and the left, the average tax rate that corporations pay is much lower than the stated rate anyway. So raising the stated number up a little bit may not cost a lot. The worst estimates that we've seen out there for the big companies in the S&P 500 is it might take something like 7 to 9% off earnings per share, but that may be the way that we need to think about it if we're going to be funding other things driven through a Democrat Senate. That said, the other piece is on trade. And on the trade side, I think it's much more about not a return to globalization, but at least a return towards, can we normalize things with Europe? And to the extent that would help European economies, it would've change a little bit of the import export balance. That's important. If you look at who president elect Biden has already appointed as cabinet members, on the far East side, it's a bit more hawkish, than I think many folks would have expected. So it's unlikely that the policies towards China will change dramatically in the near term, far more likely that there'll be a resurgence around UK and the European Union. So that could be a relative positive. That said, if Georgia elections both go to Republicans, there's unlikely to be meaningful change across anything related to taxation, but I still think you'll have a pivot on the trade side. So that taxation piece is the big one. I think on the trade side, the main risks around a Republican Senate would be really towards Asia and how strong the Senate would likely be in terms of the trade opportunities there, whether or not we lift tariffs, for example, and depending on how a president like Biden treats those or president Biden would treat those. So that remains to be seen. And a lot of guessing at this moment, we wanna be a little bit more cautious. And I think, as I said at the beginning, the idea is to go into 2021 with as much flexibility as possible because things may change.

Mike - Yeah, thank you, Chris. A couple of questions have come in around real estate, and it varies, it's from the consumer individual side, the suburbanization or the exodus of urban. Some of those trends, perhaps some trends like commercial real estate. And specifically, a question around, here we are working remotely, do those trends continue, and what kind of headwind does that pose for asset categories like commercial real estate?

Chris - So interestingly enough, I think, two things come out of COVID that are likely to be fairly permanent. Permanent just means that the balance shifts rather the percentage will be precise over 10 years or so. But one thing is we've reversed it a decade long trend towards urbanization. And I think what's important about that is you've seen suburban markets in critical areas where there's a combination of innovation, technology, money, culture, et cetera, and enclaves, whether it's Jackson Hole, Lake Tahoe, Palm Beach, whatever, tended to have tended to do relatively well. That's important because they think that the opportunity for most investors around real estate is to understand whether or not those things changed. Urban densities were still in a good place, unlikely to grow at the same rates that we've seen in the past. I think it's a little bit worrying. There was an article today in one of the news services about Manhattan with a decade, low rents, still not attracting a lot of people. It's gonna take a while. And I think that healthcare bridge that we've talked about is probably the thing that we'll need to look for more confidence in. That said, I think there's lots of interesting opportunities that will come through on the real estate side, whether it's in distress, because there's likely to be lots of pressures. Companies retool their efforts to deploy people in appropriate ways that you can find that you can work from home so much, the better in some cases. I think two is, we're likely to have a secondary effect of what COVID should bring to a real estate markets in secondary markets. And so you can think about the Amazon application of a real estate, whether it's in warehouses, in tier two airports, tier two cities, that kind of thing. Or if it's the taking of floors in urban areas where you just have them as hubs and delivery centers, just the nature of how we think about real estate is a building for one thing, a building for office, a building for that I think is likely to change in a number of different ways, but also suggest there's some opportunities, particularly as we've seen a lot of the redevelopment work, now work go towards community rather than a building for a specific purpose.

There's always things going on around it. And I credited a lot of the opportunity zone legislation for helping to continue to push in that direction where you're building communities rather than an individual building for X or Y or Z purpose. So I think those are some interesting trends around that, will office densities be the same? Probably not, but are they gonna crash? So that there's a whole sale, a partial sale... No, I don't think so. But I do think some other interesting trends beyond warehousing are also worthy of consideration. We're looking at things like multifamily, for example, around real estate. Still looks very interesting is kids come out of their parents' basements as well as opportunities for development in certain areas. So, we still see some in-migration in certain parts of the country and behind all that will be some other changes, potentially driven by climate that we do wanna consider as well.

Mike - There is a question here, all of these benefits of stimulus, at what point does the cost of debt become an issue for the United States? I think our national debt is approaching, if it hasn't already, $27 trillion, structurally we spend more than we make. And it just seems like there's no into the amount of debt that will take on. It's great while rates are low. And as I mentioned, the government can today borrow ten-year money at 90 basis points, but that's not gonna be forever. So what's the prognosis as you look forward on debt and deficits.

Chris - I think they're gonna be with us for a very long time. In fact, they've been with us since the World War II. So in some form or another, it's very rare to not have deficits, and academics and the econometricians debate these points to a great degree on whether or not they are forcing moments. You have too much debt, et cetera, or there's something else. I'll make two points about the debt and deficits, and why I think in the very near term, there are unlikely to be a huge political stumbling back to continuing the stimulus function. The first is, it really matters the most around debt and deficits when you owe other people money. When you owe yourself money, or at least to a large degree, Japan is the big lesson there, things don't really change that much. You can pull money out of one pocket and put it in another, it's a glib way of framing it, but that's basically what happens. The second piece is I think many political leaders have at least a visceral, if not an intuitive understanding of some research that has been done over the past 10 years, that looks at history. And it looks at what happens when governments are too austere. It's a great paper called Austerity and Anarchy that helps summarize this, but there's 10 others. They all get to the idea that if you starve your population of funds or benefits or liberty or other things, you tend to get uprisings, you tend to get revolutions. At least that's the history in Europe. So that seems dire, but I think that's an emphasis on where might the political will lie as to help ensure that we're using debt and deficits in a way that is beneficial across a broader group of people. I think the challenge here is that it's been pretty narrow at least in the last round or it was pretty broad last round. The next coming round might be a bit more narrow and we'll see how that plays out. That's typically an election type of thing, but what the way to 2022 to see those things come around. So to finish the point then Mike, I think we're okay for now. Where would it become a a point that will likely create a forcing moment? Well, the way we've thought about it is this, the federal budgets worth trillion give or take, by the time you're 15 to 20% of the budget as interest payments, even to yourself, you're gonna crowd out other things. And so we're not quite there yet, and we're probably a couple of years away from that, but it wouldn't stop, say Tea Party, or other political parties from taking the debt cudgel and beating the other party with it over the course of 2021. It's a source of political noise. But I think from an economic perspective, we're not so concerned with it for at least a few years.

Mike - I appreciate the nighttime reading tip, Chris, that was called Austerity and Anarchies I'm gonna have to look what you really read. That's interesting.

Chris - Have fun.

Mike - Question here on green energy and call it clean energy, but maybe I'll take it a little more broadly as you think about investing ESG or environmental, social and governance. How big of a category is this becoming from your perspective as you invest money on behalf of clients?

Chris - Yeah, very big. Market's moved there. Whether our clients know it or not, there could be a meaningful proportion of their assets that's already invested along these lines as many asset managers, BlackRock being a very good example, already have a big proportion of their assets invested this way. And if you're buying equities in Europe, something approaching 80% of the equities managed by European managers are already invest with these types of principles around sustainability. These aren't necessarily a bad thing, but they are, I think, indicative of where the industry is headed, number one. Number two is, with all the financial technology and the research over the last 10 years, I think the best thing you can say about these approaches is they don't cost you performance. I think folks that claim they do are misguided or misunderstand how powerful financial engineering actually has become so that you can replicate risks in a way that make you look like a stock market index or whatever is you're trying to do. So there's an opportunity there both around education. And I think where clients wanna create stronger alignment between what's important to them and what's available in the marketplace, I think we're going to continue to see that. And frankly, since there's a lot of incentive programs, at the very far end, the investing end, for companies to do things of this nature, solar firms, tax credits, et cetera, and none of those look likely to go away, regardless of who's in the presidency in the next four, eight years. I think we have some meaningful flows of capital that will move in this direction and continue that pole as not just an environmental opportunity, but just an economic opportunity outright.

Mike - Chris, a question on, and some of these are fair or not fair, but just always good to get your perspective. But a question from someone named Neil. Neil wants to know when business travel will resume and whether these Zoom meetings are fleeting or is this a little more of a secular change in the way we do business? I guess one thing I look at is the TSA tracker the government puts out and we've got maybe 600, 700,000 people going through airports on a daily basis. The worst was April. It was 88,000. But in a normal year, it was 2 to 2 1/2 million. So we're not there yet. But maybe thoughts about travel hospitality, in general, and Zoom meetings?

Chris - Well, I think if you're a traveler, you probably like this, it's easy to get through airports, et cetera trying to make a happy out of what's a difficult situation. I think it's really two things. And I suspect many of the big international carriers are gonna show us the way on air travel. Some combination of either proof of vaccine, immediate testing, or some kind of rapid testing, plus masks, temperature, you name it are all gonna be part of the story going because you're forced in a small space to commune with others. You wanna have a reasonable degree of confidence that everyone else is similar to you, meaning not infected and not a carrier. So to the best that firms can do that, I think it will require additional investment. There've been a couple of articles out there. What we see for some of the carriers emanating from Asia, they're likely to go down this road. So there'll be a bit of an experiment on that front. I think Delta in the US is another example where they're gonna try some of these things, but the combination of vaccine plus rapid testing is really, I think the way to go, we just don't see those things fully deployed yet. So it's a little bit of two things working together that need to happen, either simultaneously or one after the other, for things to resume. As far as Zoom goes, like we're on a Zoom call. I think virtual calls will be with us going forward. And I think there'll be less however driven out of fear, which mandates the massive use, and more driven out of convenience. So fear and convenience are working together to really force a lot of these things higher, but as fear subsides, convenience will take over. And convenience is actually determined by other things, people's schedule, the desirability of the business, the trust required and the level of business that you're doing. There's other factors that may see that return to air travel. I don't think it's unreasonable post-vaccine and with rapid testing, et cetera, to get to a place where we're back in the 1 1/2 to 2 million somewhere in 2022.

Mike - Yeah, a couple of questions around gold, Chris. Gold up, I think, 20% this year, but maybe more broadly commodities. Gold tends to be the safe haven when we're all worried. And yet we just talked earlier about the market's going up whether it's real estate, whether it's stocks, even bonds. So it seems like every asset category is up into the right, but any perspective on gold and commodities?

Chris - Gold is an interesting asset. I think the clients want to hold it a little bit, it's not going to hurt. We've looked at it and at various points that it may make some sense in portfolios to deal with things like political Turbulence or global instability. I think some of those fears have abated post-elections, so to the extent that political stability, at least at a global level may return to a degree that opportunity, I think, for gold. It's gonna be a little bit more challenging. That said, a lot of what gold gets priced on is how the dollar works. So to the extent, that a dollar is a lot weaker, COVID goes away and things look stronger outside the US, and things like Indian jewelry demand pick up very strongly. You could see gold actually behave relatively well. So I think from a standpoint of right now, when I hold it as a hedge, maybe just a little bit. But I think there are other ways to do that, particularly if you're looking for investments that will at least pay you while you're waiting, like dividend paying stocks, for example. But beyond that commodities, I think more broadly, we're in a place where if the world's running at at 2, 2 1/2, 3 in the developed markets. Emerging markets closer to five, average is 3 1/2, something like that. That's not enough to create monster shortages, more mismatches between supply and demand around most commodities without some meaningful change in the supply side. Now we may see that around oil, but the reality here is that most commodities are likely to be in a flattish trend with the exception of a few that may be more associated with centers of production and tariffs and trade rules. But from our perspective, commodities should be a small piece of overall portfolios, I think at this point.

Mike - And maybe this isn't fair, but it's the next most popular question, crypto and Bitcoin, particularly as a hedge against the dollar.

Chris - Well, I guess it's--

Mike - You're free to pass.

Chris - So that's, three comments here. We've talked a lot about it. I think we're in the process of revisiting how we look at the blockchain technology. We've been pretty positive on blockchain. I probably saw some recent announcements. The finance industry, travel industry are likely to be very big users of blockchain, the technology underneath Bitcoin, that's gonna go everywhere. That looks like there are some very interesting opportunities to speed transactions and make them more secure. And that's a wonderful thing in a digital world, because digital security is the thing that goes right behind the growth in the Internet. If you don't have it, Internet really doesn't grow. However, as you go to the other side of the coin, the use of that digital security, for other means, say in this case, as a coin or a store of value, is a little bit harder to see. There's a lot of challenges around how those things work. And to the extent, they're not that big, they're not all that liquid. And they're dominated by big institutional players, hedge funds and others moving them around. It's very hard to calibrate what the value is. Last point is those that are believers in these kinds of things have made some extreme claims, Hey, it'll replace all the currency in the world and a whole bunch of other things like that. And they forget something. They forget that governments make rules. And it is very unlikely that governments who need senior rich, remember that point about paying debt in your own currency are going to willingly give up their ability to pay their own debt. I think that's just something that, there are numerous examples around governments changing rules. Our own new fed programs, Japanese Central Bank saying, Hey, we're going to buy exchange traded funds, governments change rules all the time. The expectation that a single thing will take over the world, just because it's better without having some government set of rules on it, I think is misguided. And ultimately it mean that Bitcoin or other things do relatively well, but the extreme version of a lot of the claims out there, I just find completely unsupportable.

Mike - Yeah, Chris, before I ask the last question here, I wanna just let our clients know if you have any questions about this or wanna meet Chris and look at some of his research outside of this call, please get in touch with your First Republic Relationship Manager or your investment advisor at First Public Investment Management. We're always happy to assess there's a lot going on. It's been an incredibly turbulent year in many regards. And I think turbulence and volatility are probably here to stay at least in the short term. Maybe, Chris, just finally, how you're positioning asset allocation and your portfolio looking out the next 12 months.

Chris - I think over the next 12 months, a couple of things. If you made it the simplest equation, I think stocks will beat cash, which will likely beats bonds. I think the real toss up here is what does better, cash or bonds next year? And I think it doesn't mean you should sell all your bonds. They serve a purpose, particularly after tax. And there's a liquidity benefit that is, when times are wrong, in case we've misjudged what the stock market does, you need those other anchors to windward. But I think the opportunity, if you're just looking straight at returns and ignoring the risks for a moment is that the stock market still has room to go because of all the operating leverage that we talked about, because I think the hardest hit areas get rebalanced. And because there aren't a lot of great alternatives, I'll put that as a framework. I think really what it's gonna depend on is how quickly earnings can recover. And to me, that's a function of how quickly we can cross the healthcare and the fiscal bridges, the stimulus bridges. So if we get across them really quickly, like say by May or April, boy, we could have a bigger turn in earnings than what you might expect out there. The consensus, for example, in the S&P 500 is about 195, $196. It could be North of 200 next year, which means all of a sudden, to the point you made earlier, which I didn't answer directly, but I'll do now, markets aren't necessarily expensive relative to history or relative to other metrics. And presumably to the growth that you might expect anchored on crossing those two bridges quickly. And that's really the big risk. How quickly do we get across those bridges? You could see meaningful upside and earnings for two reasons. One is that leverage I talked about. And second is, companies tend to be cautious coming out of slowdowns in hiring. They will be slow to rehire people, which means they'll have a period where their profits are over joyed or in an excess mode for a period. And I think you could see that in 2021 if we cross those bridges fast enough.

Mike - Great, Christopher Wolf, Chief Investment Officer of First Republic Investment Management. I didn't want to distract you, Chris, but I do understand it was your birthday yesterday? So very happy birthday to you and to our clients out there. We really appreciate, first of all, giving us the privilege to serve you, but secondarily, just wishing you a very healthy and happy holiday season. So thank you very much, and we'll be back next quarter. Thank you.

Chris - Thank you.