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Joe Davis: 'We Will See China-Like Growth for a Time in the United States'

Vanguard’s chief economist discusses his team’s latest research, how the pandemic has changed the economy, and the future of work.

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Our guest on the podcast today is Joe Davis, global chief economist at Vanguard. Joe also heads up Vanguard's Investment Strategy Group, a team that conducts research on portfolio construction, develops the firm's economic and market outlook, and helps oversee Vanguard's asset-allocation strategies for both institutional and individual investors. He is also a member of the senior portfolio management team for Vanguard Fixed Income Group. He earned a doctorate in economics at Duke University.



Asset Bubbles

Bitcoin: Digital Gold or Fool’s Gold?” by Joe Davis,, March 13, 2018.

Vanguard’s Joe Davis on the State of the Markets & the Global Economy,”, Jan. 28, 2020.

Asset Bubbles and Where to Find Them,” by Joe Davis,, March 8, 2021.

Value vs. Growth: Widest Performance Gap on Record,” by Katherine Lynch,, Jan. 11, 2021.

The Pandemic and the Economy

Vanguard Economic and Market Outlook for 2021: Approaching the Dawn,” Vanguard Investment Strategy Group,, December 2020.

Vanguard Economists Discuss Their Global Outlook,”, July 23, 2020.

The ‘Great’ Fall and the Road to Recovery,” by Joe Davis,, May 1, 2020.

A Pandemic, a Vaccine, and a Sea of Ideas,” by Joe Davis,, Nov. 10, 2020.

The Key to Achieving COVID-19 Herd Immunity,” by Joe Davis,, Jan. 27, 2021.

A Timetable for Overcoming COVID-19,” by Joe Davis,, Feb. 1, 2021.

Vanguard’s Joe Davis Talks Healthy Economy Amid Covid,” Bloomberg, Feb. 8, 2021.


Vanguard 2020 Outlook: The New Age of Uncertainty,” by Joe Davis,, Nov. 18, 2019.

Inflation Prospects Amid the Pandemic,” by Andrew J. Patterson,, May 20, 2020.

Envisioning a Post-Pandemic Future,” by Joe Davis,, Sept. 1, 2020.

Market Outlook

Vanguard Comes to Defense of the 60/40 Portfolio As It Forecasts Stock Market Returns for the Next Decade,” by Steve Goldstein,, July 25, 2020.

A Sharp Contraction, Then an Upswing,” by Joe Davis,, March 22, 2020.

Why Portfolio Diversification Still Works,” by Amy Arnott,, March 30, 2021.

Active Fixed Income Perspectives: Q1 2021,” by Active Fixed Income Leadership and Research Teams,, Jan. 28, 2021.


Megatrends: The Future of Work,” Vanguard Research,

Automation Isn’t the End of Jobs,” Interview with Christine Benz and Joe Davis,, Nov. 24, 2018.

Quantifying the Future of Remote Work,” by Joe Davis,, Nov. 30, 2020.


Christine Benz: Hi, and welcome to The Long View. I'm Christine Benz, director of personal finance for Morningstar.

Jeff Ptak: And I'm Jeff Ptak, chief ratings officer for Morningstar Research Services.

Benz: Our guest on the podcast today is Joe Davis, global chief economist at Vanguard. Joe also heads up Vanguard's Investment Strategy Group, a team that conducts research on portfolio construction, develops the firm's economic and market outlook, and helps oversee Vanguard's asset-allocation strategies for both institutional and individual investors. He is also a member of the senior portfolio management team for Vanguard Fixed Income Group. He earned a Ph.D. in economics at Duke University.

Joe, welcome to The Long View.

Joseph Davis: Thanks for having me, Christine.

Benz: Well, it's great to have you here. I want to talk about a paper that your team recently came out with on asset bubbles. And one of the points you make is that big price increases aren't necessarily a signal that an asset is in a bubble. Assets that have gone up a lot are more likely to continue to go up than go down. So, if price increases aren't a good guide to what is overpriced, what do you think is?

Davis: It's a great question, Christine, I think really relevant for the market today. It's clearly fundamentals. And I don't think that would be a surprise to your listeners. Hindsight is always 20/20. And so, price increases in and of itself, although they can be surprising, it's important to anchor relative to what are fundamental values for any asset. It could be land values for real estate; it could be, certainly in the U.S. equity market, things such as the level of interest rates, and more importantly, earnings relative to that price. And so, those are the sort of metrics that we look at to try to assess what a fair value is for any asset or investment opportunity. And I think that's important to keep in mind, certainly in this environment.

Ptak: You mentioned the U.S. housing market in the paper noting that despite sizable home price increases in certain markets, that appears to be related to supply/demand imbalances in the wake of the pandemic rather than speculative access. Can you walk us through your thinking?

Davis: I think there are three factors, which I think the housing markets are great examples of why despite very heavy home price increases, particularly in certain parts of the country, I'm hard-pressed to at least find significant evidence of a bubble. And again, a bubble is by definition, a significant, in one sense not defensible, deviation from an asset's fair price over the long run. And so, when we look at the demand/supply imbalance in the housing market, it's actually pretty acute. The housing inventories in some of the hottest markets are actually among the lowest on record. And if anything, it's been a remarkable surprise for me during COVID-19 demand has increased significantly in certain housing markets at the same time supply has just not kept up. And so, much like any sort of commodity or other good, it's not surprising to see the prices rising significantly.

I think the second factor is the fact that the cost of financing is incredibly low so you can justify some of the price increases. Now, that does not suggest that home price increases will continue indefinitely, because at some point, affordability will become an issue. But again, supply is low, one. Second, cost of financing is extremely supportive. And third, there's not incredible amounts of leverage in the system, which you also tend to see with unsustainable price increases. So, all three of those would point to me as evidence that I'm hard-pressed to see evidence of a bubble in the housing market.

Benz: Let's talk about cryptocurrency, which you did discuss in the paper. You think that that area is more worrisome from the standpoint of frothiness. Can you talk about that and how we would know if cryptocurrency is overvalued?

Davis: Thanks, Christine. It's actually one of the more challenging questions to answer, in part because it gets back to that fundamental value. It really depends upon one's assumptions of what the future state of use and adoption of cryptocurrencies may be, Christine, because that will ultimately determine what the fair value for cryptocurrencies’ value. Some argue it has a great deal of utility and that there's a likelihood in the future that cryptocurrencies become effectively the default measure of exchange, much like we use paper currency today. I think that could happen. I think there's also risks to that view. And that's why we try to articulate, some which doesn't seem to be discounted at all in certain cryptocurrencies’ value. And some of those risks include the fact that it is extremely volatile. And so, by definition, at least right now, it's tough to defend it as a really medium of exchange.

More importantly, is the very nature of the technology itself. And so, the history of technology shows, at least to me, that you can have improvements in even cryptocurrencies themselves, which will actually obviate the utility of the current generation of cryptocurrency. So, in one sense, some argue that, well, cryptocurrency is valuable because it's limited in supply and so, the risk of "printing money" is less. Well, that's true, but you could have infinite number of cryptocurrencies themselves. And so, I think that's really the tension. And you have smart people on either side of that argument. I'm more skeptical because I think, at the end of the day, central banks will adopt similar technology, which will really depress the value of these alternative “currencies” if you will. But again, history is not written on this matter.

Ptak: You also single out low-quality U.S. growth stocks as appearing frothy today. How do you define low quality in this case?

Davis: Well, I think that's just the combination of really very little, if any, earnings, which tends to happen in younger companies or in certain fields such as technology, Jeff. But at least over the long historical record, companies that tend to be ranked lower on the value spectrum, i.e., more growth companies, so high price/earnings if they have earnings at all. And then, secondly, the lower quality of the earnings. So, effectively, the E is even lower in that equation or negative. Historically, those companies as a portfolio that have these characteristics have underperformed the broad market, which is why you hear some talk about factor risk premiums, such as value-type stocks. But that certainly has reversed and has not been the case over the past decade, and in fact, growth companies' outperformance has been eye opening and nearly unprecedented over the past 10 years. And then, the question is that recent trend, A, does it reverse, or is it this time different? We believe it will ultimately reverse given the things that we can get into.

Benz: One question that has come up a lot recently is whether this period is analogous to the late-‘90s period, the dotcom-bubble period. What do you think are the major similarities? And what do you see as the key differences?

Davis: Really good question, Christine. I think there are certainly two similarities. One is, and actually, if you even go beyond just the late-1990s, any time in human history, financial market history, where there's been a bubble, there's at least two characteristics, generally three, two, which I think are in place today, and it's questionable on the third. One is, there's a compelling narrative that this time is different. And so, typically, there's a new type of asset or type of company whose value has really risen dramatically. It's everything from the South Sea to different stocks in the late-1990s, obviously, tied to the Internet. Today, it's new forms of technology, nevertheless, it has the same sort of characteristics that these sorts of companies or industries are going to "change the world." And some of that may clearly be true. I mean, some companies emerged out of the 1990s that ultimately changed retail. Amazon is a good example.

And then, the second one really is a significant, and in our judgment, too significant of a discounting of future growth. So, that's where I think there's, in our mind, a deviation between the growth prospects for these industries and companies and what will realistically be delivered, even if their growth is still substantial in the future. So, for an example, some companies, their valuation or their price today effectively assumes that they own if not the entire part of their market in their business, but if not all of it, at least a high percentage of that. So, effectively, what happens in bubbles is that I think one of the underpinnings for its ultimate deceleration in price is that they underestimate either regulatory change, or I think more likely going forward, new entrants, which actually compete on market share. And it's the very capital and the price appreciation and technology and innovation that actually increases other future market competitors. And so, I think that, at times, investors have tended to underestimate that point and instead have really become fascinated with the growth prospects. And I think that is the environment we're in now for some companies, not all and it's not very broad based, but it's certainly in parts of the U.S. and global equity market.

Ptak: Do you think the recent rally in value stocks compared to growth has addressed this issue somewhat? Or is there still ways to go on the growth versus value imbalance?

Davis: Well, Jeff, if you give us several years to look out, because I think that's important, because no one and certainly not us will get the timing right. There's elevated odds that ultimately the underperformance of value, not all of that, but a portion of that will be unraveled. And so, value stocks are likely to outperform growth stocks in the future. Now, part of that reason is the macro fundamentals. If you believe the market, if you believe the consensus scenario over the next several years, there should be an improvement in growth and modest rise in real interest rates. That's important because the macro fundamentals have explained roughly two thirds of the value stock universe's underperformance over the past decade. It just didn't happen by accident. Some of this was well justified.

Something else happened roughly six months ago. And so, in addition to macro fundamentals potentially being a tailwind, i.e., a global recovery, for value stocks. The second one is much more of just the increased overvaluation of growth even relative to those fundamentals. And what we talk about in our papers that even when we give growth companies the benefit of the doubt of what we call technological change, so R&D expenditures, changes in platforms, greater investment and demand for those type of services, even when we credit that as an asset rather than an expense, which is typically done in accounting, they are still overvalued in our framework. And that only happened very recently. So, this wasn't the fact that at least to us growth stocks have been overvalued for several years. It's actually a much more recent phenomenon. And when that has happened, again, at least historically, with the benefit of hindsight, there's generally been a reversion to the mean and a modest underperformance of whatever asset that's significantly above those fair value metrics. So, I think it's that second point in addition to the first that give us higher than average likelihood that over the next several years the value premium will be realized for investors, which actually would be good news because as you know--and Morningstar has documented value stocks--have been a significant underperformer in a globally balanced portfolio for at least a decade.

Benz: We want to go back to discuss your market outlook later on. But before we do that, we wanted to do some stage setting by talking about your team's economic outlook, starting with COVID. In your team's global outlook for 2021, you noted that that outlook was hinging almost entirely on health outcomes. And now that we're three months into this year, what do you see when you assess the COVID response and the vaccine uptake globally?

Davis: Thanks, Christine. And I'm really proud of our framework. It was the first time we really had a focus on health, as you note. And much like we assumed at the beginning of the year, the economic picture would really be dependent upon how quickly we would close on what we call the immunity gap, the percentage of the population that has been vaccinated, or has acquired natural immunity. And then, with that, we would see an increase in consumer confidence with respect to social-based activities, restaurants, travel, and so forth, and then, with that, obviously, higher economic growth.

Our assumptions--they've generally been tracking--very recently, we're sitting here today as we approach into April, the vaccination rates in some markets are in line with our projections. In the U.S., they are starting to track even above our initial estimates after, quite frankly, getting slowly out of the gate. So, I think right now, we're still anticipating strong economic growth. We were above consensus at the beginning of the year. We still remain above consensus. And the growth picture has increased, I think, across the board in the financial markets because of the fiscal stimulus. So, it's likely that in the next 12 months we will see the highest growth rates in the United States that we've seen since perhaps the early 1980s. We will see China-like growth for time in the United States.

Ptak: What grade would you give the U.S. policymakers for their response to the COVID crisis thus far? And maybe I would add to that by asking, given the sunny growth outlook that you just described, what do you think is a correct policy stance for them to take in view of the fact that sometimes higher inflation accompanies that type of growth?

Davis: Sure, Jeff. I think, early on in the crisis, we and others in the asset-management industry, both applauded some of the very timely and aggressive policy responses, both from the Federal Reserve as well as from the Congress and for other central banks and policymakers around the world. And so, it was it was a very significant response and it was fast. And it's something that we would give counsel to policymakers when they were interested in our view and continue to do that. I think we will certainly not see the low-growth environment that we saw coming out of the global financial crisis, in part because of the significant policy response. In totality, we are seeing, at least in the United States, nearly unprecedented policy response. You have to go back to World War II to look at the policy stance as aggressive and as accommodative, collectively monetary and fiscal, as we see today.

It's not a surprise to hear a growing concern with modest inflation returning given the fact the growth numbers that you and I just mentioned. And there's some emerging upside risk to inflation. It's not for tomorrow, but it's a little bit longer term and something that we will have research coming out. And so, I think the trick will be if we hear about additional fiscal stimulus beyond the $1.9 trillion that was recently enacted, is how do you pair the needs for additional investment, particularly around infrastructure, which quite frankly, there are needs--how do you balance those needs for new government investment with the funding of effectively how to pay for that greater government expenditure? I think that conversation will have to occur. And then, there will be some debate there in terms of what is that right balance. But at some point, the more we go into the government spending side, the more we just have to have that conversation with respect to tax receipts to actually offset the expenditures.

Benz: We have some more questions about inflation. But before we go there, why don't you just talk about your outlook for the U.S. and Europe? In the 2021 outlook you wrote that you were expecting to see 5% growth in both the U.S. and Europe. But does the smoother rollout of the vaccine in the U.S. relative to Europe affect that forecast at all?

Davis: Modestly, Christine, but they're still pointing in the same direction. The most material change, and I think it's for everyone who's been looking at the markets, has actually been the increased stance and pace of fiscal stimulus. We had assumed that we would see at the end of 2020, but it's been well beyond even our expectations. And so, the $1.9 trillion recently enacted in and of itself will add several percentage points to those growth numbers. So, if we were already talking about strong growth, again, part because we are coming out of a very deep recession last year, we are projecting even stronger numbers. And I think the market has started to discount that, meaning to expect that. But we still see risk on the upside if we look over the next 12 months, because, to your point, vaccine distribution--knock on wood--is continuing to meet or exceed expectations.

Ptak: We've also seen some bifurcation in emerging markets with emerging markets and Southeast Asia generally recovering more swiftly from the pandemic than those in other parts of the world. How does that affect your outlook for growth in Asian emerging markets versus emerging markets elsewhere?

Davis: Sure, Jeff. Again, our thesis and framework was that a healthy economy begins and ends with health in this environment. And so, those economies, those regions of the world that more quickly closed the immunity gap, we're going to see, first and foremost, the more rapid growth. And I think we're going to see that. What has not changed is, we are going to effectively see an eco wave in terms of economies taking the lead in terms of growth and the pace of recovery. Obviously, it was initially led by China, U.S. quickly coming up the leaderboard, so to speak. And then, you're going to see some emerging markets lag. And it really depends upon that combination of effectiveness in controlling the virus as well as the efficacy of immunity and vaccine distribution. So, in that sense, our outlook of that eco wave or sequence of growth hasn't changed.

Benz: You mentioned a few of the things that have been potentially affecting inflation. I wanted to ask about these supply chain issues that we're seeing. How do they affect your view of inflation? It seems like there's this semiconductor shortage that's weighing on manufacturing right now. And it seems like there are long waits for everything that you might order, whether sofas or cars or bikes. So, how does that factor into your thinking on inflation, Joe?

Davis: Sure, Christine. I mean, it is a factor. It will push up inflation modestly over the next several months, Christine. But at least by our assumptions, they are still nevertheless temporary. It's another reason why we expect what we called at the beginning of the year an inflation scare that's coming. In fact, we will be approaching it very shortly. I think ultimately, it will fade for a time in part because of those supply constraints will ease. What is, however, growing in the horizon, particularly when we start to look out into late 2022 and beyond is the tendency and the propensity, which I think the market is potentially underestimating, the potential if we continue to see fiscal spending, that sort of influence that has on expected inflation. In other words, the numbers that you and I expect to see for wages, prices paid, and companies expect as well. It's what economists call inflation psychology. It's what the central bankers call stable inflation expectations. They started to lift. And if we continue to see fiscal spending like it's being currently discussed, I think we will see modest more upward pressure on expected inflation. That is important because that will then likely lead to a little bit more permanent higher inflation. Now, again, not drastically high, but we will certainly breach 2% on a sustained basis if we're right. But that's more than a year from now. So, right now, it is just the growth recovery, the service sector coming back online and your supply constraints, which will all lead to a boost in inflation, some of which will dissipate.

I think the more important and pressing question is when we work through that period, where is trend inflation, which for 20 years, central banks have struggled to attain 2%. It was our thesis and has generally been so, but we are starting to see a modest change in the risk assessment of our inflation projections. The first time I've seen that since I've been actually at Vanguard. And we're not calling for a return to the early 1970s or the late 1960s. But the risks at the minimum are more symmetric, and they're starting to become modestly on the upside the further out we look.

Ptak: If I'm a bond investor, should I be worried?

Davis: Well, I think you have to worry if the market is not discounting that Jeff. I think what's been, I think, important, and something we anticipated was that breakeven inflation, so the bond markets' best estimate of where future inflation will be, that now has finally gotten to a level that we deem as reasonable. So, the treasury market is effectively assessing the risk of roughly 2% to 2.5% inflation, which is above the Fed's long-term 2% target over the next decade. That's certainly more sensible and realistic to us than where it was just several months ago, when it was skeptical, we would ever see inflation. So, those expected inflation rates were well below 2%. And in fact, at one point early in the crisis, were even below 1%. So, I think we're in a more normalized environment. We don't anticipate a material further rise in expected inflation. I think we will see modest higher interest rates, but that will be because of a combination of two things. One is the real, our long-run real inflation-adjusted yield should continue to modestly rise if our outlook for growth is important. As you know, Jeff, real interest rates are negative on any horizon in the bond market. That seems inconsistent when you start to look out at growth a little bit longer term.

And then, secondly, at some point, the Federal Reserve, if we're right on our growth and inflation projections, will start to finally lift off from the zero bound. We're not there yet. We likely won't be there next year as well. So, I think there will be more adjustment in short-term interest rates and intermediate interest rates, but we don't see a material doubling that I've heard some perhaps wonder about in terms of interest rates. We will see more normalization, which I think ultimately for investors, it's good news. The one unfortunate outcome of the crisis is that the zero interest-rate bound is really right now, if they don't change, is lowering the expected returns on all investments, private or public. And so, the sooner we can start to lift out of that environment, the better that is for longer-term portfolio returns, even if there's a modest period of adjustment, when the Federal Reserve tightening cycle is brought into view.

Benz: The economic effects of the pandemic have been unevenly distributed with some knowledge workers in a better position economically today than they were a year ago. And then, people in other occupations have been really hard-hit financially. So, is there a chance that inflation could also be unevenly distributed, that some people will see higher prices on the stuff that they want to buy that some of those higher-income workers will see inflation and other workers, other people might not?

Davis: It's certainly possible, Christine. I think there's many unfortunate aspects of the COVID-19, the global pandemic, just the trauma economically has really been centered on certain industries and just certain occupations. It's been unfortunate. And some of those headwinds remain. Just for recollection, particularly the price increases we saw for certain essential commodities, particularly around food was pretty eye opening. And again, for those that have lower income, higher percentage of their budget by definition spent on food, because they don't have the wherewithal to be spending on more discretionary items.

So, I think what we will see is twofold. One is, if we're right with the economic outlook, we will see an improvement in the labor market. And the vast majority of that improvement will be from what we call the face-to-face sector of the economy, the service-based economy, hotels, restaurants, etc., start to resume a little bit more normal activity. That should be supportive for the very workers who have had a lot of suffering.

Secondly, the supply constraints on certain of those commodities that we saw, particularly in food, hopefully some of those will ease. And so, that could be a powerful double level of support. Again, may not be a great deal of solace for certain households who have had weather high unemployment, higher food prices during this past year or more. But that should partially offset. And again, I think it stands noting that all this came at a time where there was growing concern and anxiety about the secular rise in income inequality in many economies around the world. This has been a global phenomenon and it was already reaching fairly elevated levels. And that was before COVID-19 hit. So, in that sense, COVID-19 just accelerated some of the disparities that we were seeing socially around the world.

Ptak: I wanted to shift to market outlook, and you've alluded to the different inputs into the way you build outlooks. But I thought maybe we could unpack that a little bit, if that's OK. We'd like to go over how you arrive at the forecast for stocks and bonds that you make, what variables factor into the forecast for each? Can you maybe take a moment to talk about that?

Davis: Sure, Jeff. I think at the end of the day the key drivers of asset prices--it's what we were talking about earlier in the podcast--really relate to the fundamentals. So, for stocks and bonds, it's really two factors: It's things such as earnings yield, which is effectively tied to profitability, and hence, there's a relationship there with our economic assumptions, and in nominal space, the rate of inflation. And then, most importantly, it's the level of real interest rates. So, the discount rate that not only influences the expected short rate for any asset--any asset, whether it's a stock fund, or a bond fund, or a private equity investment, or a portfolio of real estate holdings, all that has is what we call an expected risk premium over and above the cash rate, which has effectively no risk in the sense of you can store it and has very low volatility. And so, those risk premiums vary through time. And so, what we do is we take initial conditions, which are really important to inform the level of real interest rates, inflation, and those factors I mentioned that influence those asset prices, Jeff.

And then, based upon our assumptions of their long-run equilibriums, we also allow for transitions, because we are not in equilibrium today on any of those metrics. And that's important, and that's been a center of our framework for well over a decade. It's based upon deep academic research, much of which we've published and revealed to the broader community and there is a level of predictability. We cannot time markets in any month, week or year. And we're skeptical of anyone who claims otherwise. But there is a modest predictability. In other words, relative to the level of interest rates, relative to valuations, such as earnings yields, or the inverse is price/earnings ratios, the shape of the yield curve relative to those factors today, you can get some confidence in how various asset classes will perform on a five- or 10-year basis. So, very little predictability in the near term. But there is certainly some predictability, particularly in our framework on our five- or 10-year basis. It's far from perfect. There's a great deal of mismeasurement and error because we're talking about the future here, which is why we do two things. One is, we acknowledge that the expected returns will and should vary through time. Not everyone does that, and I think on a five-, 10- or 15-year horizon, one's expected returns should vary through time because the macro fundamentals do.

Secondly, we always show our outlooks in a range of outcomes. And we are revealing the amount of precision or conversely, the lack of precision, some of our estimates have, and I think that's the right way to do it. So, we always present our outlook and the distribution of outcomes. But I know there's many readers that will care about the median. The mean is what the average return is, and we certainly will disclose that. But I think it's just as important to say where the risks are tilted relative to the recent past as well as going forward because that's critically important to devise a strategic asset allocation.

Benz: Delving into that outlook, for equities, you expect that non-U.S. stocks will perform better than U.S. over the next decade. Can you walk us through how you arrive at that?

Davis: Sure, Christine. Again, I think the valuation is the most critical driver. The relative earnings to prices or conversely, prices to earnings, in the U.S. versus other markets. Now, there's some reasons why the U.S. has a higher multiple P/E ratio today, part of that is just the different industry profile. In other words, the U.S. tends to have a higher technology leaning, and we all know what technology stocks have done. But our assessment, there's a number of contributors to why more likely than not non-U.S. equities will modestly outperform the U.S. going forward, but it's mostly not currency. It's not the fact that this is a so-called macro call that the U.S. dollar will weaken significantly; it actually doesn't even require it significantly. It's much more where the valuations are. And then, broadly speaking, if the IMF and broad economic projections are even close to being right. If they're even close, if they're in the right direction, that should also be supportive of parts of really any market outside the U.S., which has underperformed the S&P 500 over the past three, five, and 10 years.

Ptak: In your team's capital markets outlook, you describe your outlook for global equities as guarded, and it sounds like high valuations are the main reason for that. Is that right?

Davis: It is. And again, we're not bearish. We're just trying to set relative to the recent past, which has been phenomenal, particularly in the past year, Jeff. I think also some of the frothiness we're clearly seeing in parts of the U.S. market, particularly in the growth space, they're not widely held. And so, that's why I think, not all assets have performed in the same magnitude at all. Large sectors of the value space, large sectors of the global economy have not seen their stock prices rise to nearly the same pace and extent. Markets outside the U.S. have not nearly performed as strongly as the U.S. And so, again, it's not just magical mean reversion. This won't just magically reverse. There has to be a relation relative to fundamentals. And it's that assessment that says, OK, past is not prologue; what has happened in the past 10 years, may not repeat. And so, we do see some reversal outside of growth and then outside of the U.S., which would be beneficial for global investment portfolios.

So, I think the big takeaway, the headline takeaway would be, we could still live in an environment where there's headlines of potential bubble concern or underperformance for a time from the growth universe and that may not mean at all that one's broadly based portfolio is experiencing negative returns, because the leadership could rotate. And I think that's more likely today than it has been for some time.

Benz: Our team has recently done some research where we have examined the best diversifier for equity risk. Not surprisingly, Treasuries fared really well and so did cash. The question is, do you think bonds will continue to diversify equities as well as they have done over the past couple of decades, especially given that yields are still really low today?

Davis: Sure, Christine. And yeah, I've read that research and Morningstar makes some very good points in the sense of, at the end of the day, we still expect the fixed income to diversify for no other reason and we just generally don't see the same volatility from high-quality fixed income as we do on equities. Obviously, lower return but with that lower volatility. I think we will still anticipate the correlation--ultimately, this gets to the correlation between stock price movements and bond price movements, which had been wonderfully negative for two or three years. That's one of the reasons for the secular decline in rates and the biggest reason for that has been the lack of really material inflation risk, which is why I think there's at least concern from investors today.

So, I'd say, where we come at the end of the day, correlations in the next decade will be modestly higher than they were for the past decade. But that's not bearish for bonds. I think that's what's being lost in some conversations I see. You can have zero, even modestly positive correlation, which actually has been the historical norm, and fixed income will still diversify. The only time where that could really change for a brief period would be if we had a significant multi-year, higher than expected inflation run-up, much like we saw in the early 1970s, where at that point bond prices fell and stock prices fell at the same time. So, correlations went up meaningfully. That ultimately dissipated. But that was a painful period, which is why I think it's always front and center of certain investors’ minds. But unless we see that multi-period, multi-percentage point, higher-than-expected trend-inflation outcome, we are going to be talking about fixed income as a diversifier for equities. And so, I don't see that changing.

Ptak: Assuming you have a portfolio of cash, stock, and bonds, what, if any, additional assets would you add to that portfolio to improve its diversification potential, and potentially its return potential over the next, say, two or three decades? Do cash, stock, and bonds take you as far as you need to go in the future as they have in the past?

Davis: Well, thanks, Jeff. That's a really good question. It's a tough question, but it's an important one. I'm reluctant what I'm going to say here, but I'm going to use the economist phrase: It depends. But it totally does. I think it's, what's one's tolerance, and how I would think about this with a client or with a colleague is, first of all, what's one's aggregate goal on the portfolio, what's the sort of return target or spending need in horizon over which they're contemplating? Because it's a very long horizon. I think that's the first order of business. Equity-like risk for the higher the return spending goal or wealth-accumulation need, and lower on the opposite end of the spectrum.

I think with that though you can then introduce other conversations when that conversation has ended. And that is, what's one's conviction around being able to identify skill in the active management universe, so-called alpha. Skill does exist. Some managers charge too much for it, but nevertheless, skill does exist. And if you're willing to take on some tracking-error risk, some active risk, that could clearly play a role in portfolios. And it's something that weigh in my own portfolio because I have conviction that the managers will add, if it's an equity fund, potentially 50 to 100 basis points in additional return over time. But I have to be patient with the underperformance. Some investors are not.

And then, finally, with that other word, we would still phrase as active risk over and above the liquid broad capital market. So, in the same way I could think about modestly adding weights to active managers in the equity and fixed-income, long-only space, I think the same sort of calculus applies when individuals talk about private assets. I think this notion of characterizing certain alternatives such as private equity as an "asset class" actually is kind of dated. I think it's because one cannot by the private equity market as an index, one has to harness the ability of one or a small handful of managers. Not to say, don't do it. I think that's the same calculus in terms of one's expectations for alpha, or I call it excess return, including liquidity premiums over and above what the broad markets may be expected to deliver. So, I think, again, it comes back to that ability to do one's due diligence. It's what Morningstar puts a lot of diligence in, in trying to identify and separate skill from luck. And I think those should be on the table regardless of what the equity market or what the outlook is from Vanguard or other firms. I think that's a fair conversation to have and something that can certainly add some value over time in an after-cost basis. But one has to be diligent and think through that problem.

Benz: We have been focused on your market and economic outlook, but we wanted to broaden the scope a bit here to discuss your team's work on what you call megatrends. And first, I'm hoping you can tell us what is a megatrend and also, what are some of the megatrends that you've identified?

Davis: Thanks, Christine. I mean, a megatrend in my mind is something that is a slow-moving yet incredibly powerful force that has the potential to significantly impact some combination of the level of growth we see globally, the level of inflation, or the distribution of that growth either across countries or within society. Examples of megatrends, which have been with humanity since our existence, have been things such as the pace of technological change, I think the nature and pace of globalization, which opens up new markets. There's winners and losers at times in globalization. Those are things that are characteristic or are representative of megatrends. They may always exist, but the pace of change or the nature of the change in fields such as either demographics, technology, globalization, as well as policy, you could think of--say the role of government could be an emerging megatrend in society. All those--the pace and the nature of those phenomena--change, which can lead to long-lasting imprints on global economies, and hence, the financial markets.

So, even having some understanding of how those megatrends, how their machines work, I think in and of itself is important, because that can at least give some insight as to how some of those trends as they unfold may impact ultimately the things we care about in the capital markets, which are the fundamentals I talked about a little bit a while ago--the rate of inflation, the rate of growth, the rate of interest rates--those are important and megatrends at times have significantly altered the trajectory of those macro-phenomena.

Ptak: One of the megatrends that your team has researched extensively is the changing nature of work, and you've provided some updates in the wake of COVID. Do you expect that COVID will hasten the trend toward remote work? And if so, what do you think are the broader macroeconomic implications of that?

Davis: Thanks, Jeff. I think it will, or it has. The future has been accelerated along a number of fronts. But when we did our analysis on the future of work with respect to remote work, we were able to look at all industries and the characteristics of all tasks within each job that makes up a job. There's dozens and dozens of the tasks that ultimately translates into a job. And we looked at the remote effectiveness, if you will, for each one of those tasks, some of which you can do very effectively remotely as you can in person, others very challenged to do so. And so, when you roll that up to across every industry, and then you roll that up to the economy, it says, some industries are going back to where they were. But it's not the vast majority of them. But you could think of things in the service industry--a bartender or other things where it's very likely to resume; parts of the construction industry, "back to normal," because of its physical intensity.

However, others were always almost as effective in remote ability as they were say in an office, some things particularly in the technology space. But what I was surprised to see is that the vast majority of industries, they are highly effective in a remote setting but not exactly as effective as the "the old way of doing things," which tells me the future is one of hybrid, which I know is talked about a lot. I don't know exactly what that looks like. But I think what we will see in certain sectors is a balance, a little bit more toward that move toward flexibility, potentially not in the office every day. However, at the same time, what our research clearly finds is that for certain human skills, human interaction is important at times--everything from managing employees, to developing relationships, to building teams. At the end the day, humans are social beings. And so, I think we will see, when we talk about hybrid, I still think it won't be as cataclysmic for the commercial real estate market as some fear. There will be an adjustment. There will be, in our estimate, over-capacity, but it will not be broad based, and every industry will adopt it and every firm I think will adopt it in slightly different ways. And so, again, history is not fully written on this, but I don't think the COVID environment, as we are living right now, will completely persist. There will be some return to human interaction in our professional lives more so than there is now. It just will very likely not fully retrace to the pre-COVID world.

Benz: Speaking of humaneness, your future of work paper in 2018 didn't settle for the idea that automation is coming for all of us and coming for all of our jobs. Instead, it argued that automation and technology are actually freeing us up from some repetitive tasks and that gives us time to focus on tasks that are uniquely human, as you call it. So, what's an example of a uniquely human task?

Davis: Well, thanks, Christine. I mean, there's actually a whole range of them. I think really things that relate to, in the psychology literature, one or two things--social skills, as well as emotional intelligence. So, doing calculations, for example, is effectively a repetitive task. But things such as thinking creatively, building and leading teams, which many managers do on a daily basis, and strategically thinking about certain issues. And I could go on and on and on. Obviously, caring for others, which is a critical component in the healthcare sector and in education as well, all of those have high uniquely human scores where computer technology is a compliment, not a substitute for.

So, I think going forward, when we did the analysis really the trick is quantifying each of those, the pull and pull: the push of computer automation and the pull of its need to amplify some of our value as workers. And when you do that calculus, we still come back to the fact that--two things: one is roughly 20% of the industries will continue to see jobs go away and technology replace them, as has been the course through human history. However, the greater change is for effectively all the industries, and particularly the other 80%, the composition of tasks is changing at an accelerated pace, which led us to the paradox, which I think was obviously disrupted in COVID-19, but will reemerge in the next three years and that is, a great deal of change in how we approach our jobs, ultimately, a greater value for the human contribution of those jobs. It will rely even more heavily on computers as an asset, not as a substitute. And will still, in some industries, still lead to job shortages, which will be the irony. We will have more computer ability; we will have more automation in some sectors and yet we will still be stuck, eventually with time, tight labor markets and job shortages in certain educational and regional labor markets. So, again, I'm not dismissive of in certain industries, obviously, the need to upskill is significant and technology is a powerful force. But for most industries, or at least a majority of them, the more that one can embrace computer as an asset not as a competitor, the more one's own career value is higher, the more one is able to contribute, and obviously the higher wage and career prospects one will have.

Benz: Well, Joe, this has been a fascinating discussion. We so appreciate you taking time out of your schedule to be with us today.

Davis: Thank you, Christine. Thank you, Jeff.

Benz: Thanks for joining us on The Long View. If you liked what you heard, please subscribe to and rate The Long View from Morningstar on iTunes, Google Play, Spotify, or wherever you get your podcasts.

You can follow us on Twitter @Christine_Benz.

Ptak: And @Syouth1, which is, S-Y-O-U-T-H and the number 1.

Benz: George Castady is our engineer for the podcast and Kari Greczek produces the show notes each week.

Finally, we'd love to get your feedback. If you have a comment or a guest idea, please email us at Until next time, thanks for joining us.

(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. Morningstar and its affiliates are not affiliated with this guest or his or her business affiliates unless otherwise stated. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Jeff Ptak is an employee of Morningstar Research Services LLC. Morningstar Research Services is a subsidiary of Morningstar, Inc. and is registered with and governed by the U.S. Securities and Exchange Commission. Morningstar Research Services shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis, or opinions, or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)