Investors would be wise to stick with their long-term plan, as risk-taking will likely not be rewarded in the current market climate, says Vanguard's Joe Davis.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser, here at the Morningstar ETF Conference. I'm joined by Joe Davis--he's Vanguard's global chief economist. Joe, thanks for joining me.
Joe Davis: Thanks. Pleasure to be here, Jeremy.
Glaser: It's nice to speak to you now; last time we spoke, the Dow was down a thousand points. It's a little bit calmer now. But a lot of those worries are still out in the market--and particularly now that the Fed has said that they're not raising rates because they're worried about some of these global issues. Do you think the Fed is going to raise rates anytime soon? Is December still a real possibility?
Davis: I think so, Jeremy. We went into the year saying two things. One is that the labor market is a little bit tighter than perhaps the Fed thinks, in part because Americans may not return to the labor force as quickly as the Fed had anticipated. The other is that U.S. growth was going to hold up in an otherwise frustratingly fragile world. And when you put those two together, you come to the conclusion that the Fed is still likely to raise rates, but that path is very moderate. We have not changed our view that, over the next several years, the Fed will be hard-pressed to raise rates above, say, 1%. So, again, it's removing some of the exigent circumstances that the Fed exercised in 2009, dropping below 1%, and hence [quantitative easing]. I'd characterize it more as a path of a dovish tightening rather than as just a march toward 2%, 3%, or 4%.
Glaser: How about inflation? It's still running low. The PCE numbers this week were still low. Do you think Yellen is right that we are going to get back, in the medium term, to the 2% level?
Davis: I think so. I think it's understandable for the Federal Reserve or for any economist or central bank to be reasonably confident the Fed is going to achieve 2%. They're waiting to see more stabilization rather than rebounds in the commodity markets and the U.S. dollar--there's a limit to how much further they can fall. That said, core inflation has been roughly below 2% for half of the past 20 years. In our minds, there's still a deflationary bias in the world globally, given what we continue to see both out of China and the emerging markets. So, I think, ultimately, core inflation should converge to that 2% level, but it could take up to 2018 before that's ultimately realized. Now, the Fed is trying to anticipate that and, again, trying to remove some of that excessive accommodation that they've had.
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Glaser: Let's talk about China. Do you see anything new there that shows that they are slowing even more than we thought a month or two ago? Or have things stabilized?
Davis: I think that various firms, such as ours, have leading indicators that suggest where the "real feel" economy for China may be, knowing that their official growth target is around 7%. And for more than a year, Jeremy, as you know, our leading indicators were suggesting a real-feel growth rate closer to 5%, actually. So, we were not surprised to see this become more prominent in the marketplace. I think, however, what has been news--because a slowdown is not news in the longer term--is the weaker-than-expected economic activity during the summer, paired with the surprise devaluation. I think some in the marketplace put those two together and feared that perhaps growth is even weaker, potentially, than 5% in a real-feel context. But I think the best we can hope for--and what, I think, is actually part of the plan out of China--is more of a stabilization in growth. But I think it's unrealistic for anyone to assume that we're going to see the sort of heady growth rates that we've had in the past. It's not part of the plan, nor do I think it's healthy, ultimately, for the global economy.
Glaser: But the U.S. can keep growing without China.
Davis: It can, but it's up to a limit. The central tenet of our secular outlook was one of resiliency for the U.S. That said, we don't want to be too complacent on that view. I think there's around 20% of the U.S. economy that, if it's not in recession, it's flat-lining at best. Those are sectors like manufacturing and export-intensive industries, which are very closely tied to global growth. But when you look outside of that, we still are of the mindset that the U.S. economy can grow roughly 2.5% and modestly add to job growth, although it may be slower in the next six months than it has been for the previous year. It's still the only major economy in the world that will grow modestly above trend. So, we're still reasonably confident in that view. But if we continue to see [global] weakness further accelerate--which is not our base case--then I think there would be a natural spillover to the U.S.
Glaser: What's the takeaway for long-term investors, then? Is this a time to make some tactical moves or to rebalance? How do you think about that?
Davis: Well, clearly, one wants to rebalance according to plan--and it's good to revisit your plan. I'd say two things. We went into the year, Jeremy, as you know, having the most guarded capital outlook that we've had since 2006. Not terribly bearish, but concerned about froth. And quite frankly, various segments of the equity and fixed-income markets that, ironically, some investors gravitated toward out of a fear of rising rates [haven't done so well]. Things such as emerging-markets debt, high-yield bonds, REITs, and so forth--those sectors have come under considerable pressure. Despite the correction, we still have a guarded view, in large part because the valuations and the risk premiums haven't risen materially enough to lead to higher expected returns. So, we're still guarded, and I think investors should really do two things. First, stick to your plan. Although we're not incredibly alarmist or extremely bearish, at the same time I don't think investors taking outsized risk positions are going to be terribly rewarded, given the current context. This is not 2009--where, assuming the world didn't end, investors were going to be rewarded with higher expected returns. That's not the case, at present.
Glaser: Joe, thanks for your thoughts today.
Davis: Thank you, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
