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Distribution of Growth Biggest Economic Worry for Vanguard

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com. With the global financial crisis now 10 years in the rearview mirror, what lies ahead? Joining me to share Vanguard's outlook for the economy and the financial markets is Joe Davis. He is the global chief economist and global head of Vanguard's Investment Strategy Group.

Joe, thank you so much for being here.

Joe Davis: Thank you, Christine.

Benz: Joe, let's talk about the global financial crisis 10 years ago. We all have our memories of the things that really shook us up. Let's talk about that period, what was going through your mind in the fall of 2008 when we saw Lehman Brothers and Bear Stearns collapse?

Davis: Well, one, I should apologize for laughing because it was such a serious moment. I remember actually before I intended to take stage that Monday for a Vanguard conference, seeing Lehman Brothers fail and just the notion of dread that came upon me. Because I didn't know exactly what would happen, but I did know that the economic fallout would be significant. 

The next six months, I think what was very important, one, that we saw obviously radical policy responses. The one thing I think I'm very proud of of our outlook for Vanguard was saying that, there's a probable chance that the global economy completely disintegrates, but I can tell you the market is assigning a much higher probability than that will likely occur. We were probably going to have a very somber period of economic conditions, but we should separate that from our investment portfolios, because the market is really discounting a lot of negative things. It was not fun. I mean, I remember my own views were being challenged with my own emotions, Christine.

Benz: And it too a while to recover.

Davis: It took a while. But I'd tell you by sticking to that and saying, listen, we actually at one point, internally, mapped where the economic growth be given where the stock market volatility and the negative returns are. We said GDP growth would have to contract twice as much as the Depression at one point. I said, you know, that possibly could happen; I think that's unlikely.

Benz: To justify valuations.

Davis: To justify valuations. That was an important mapping for myself and I think for some of our clients. If anything, the investment returns have been even stronger than I would have expected. We were more bullish than most in 2009-2010 from the investment perspective. But if anything, it's certainly been stronger.

Benz: Would you talk about how the recovery has played out? Has it played out, it sounds like, fairly in line with your expectations? Were there any surprises or any things that played out differently?

Davis: I think, there were definitely some surprises. We were generally of the view that the recovery was going to be slower than average. If you are self-critical of our outlook, I would say, we were still a little too optimistic on growth. We were still closer to 2.5%, when some years it was like a best 2%. I think we thought the Federal Reserve at one point would normalize a little bit more quickly than they did. We were very accurate on inflation was not going to take off. There were concerns that either inflation would take off or it would go negative …

Benz: Because of all the stimulus.

Davis: … because of all of that. Generally speaking, it was fairly good. We were very good in terms of the equity risk premium and our outlook for stocks, broadly speaking because we are valuation-based, and we said that that will matter. That was generally a good record, but it was far from perfect. 

Today, I think we're trying to challenge ourselves because I think most asset management companies have a similar outlook, which always concerns all of us, right, everyone seeing the same thing. I haven't found what the secret, the unexpected risk is, but that's something we're challenging ourselves.

Benz: In terms of the recovery, are there any aspects of the recovery that are concerning to you? We have low unemployment, a lot of things that are right about the economy, but one big thing is just that we've seen the income trajectories of some workers go in the opposite direction. Is that a concern to you?

Davis: It is definitely a concern. It's something we follow actually. We have had a mindset that many elections around the world, Christine, we don't have any unique insight on geopolitics, but we generally are of the view that most elections will always be closer than the polls would suggest because statistically we have found a link between the rising income inequalities and some of these other trends we are seeing in the political sphere. 

I don't see this trend reversing unless we would see a profound increase in productivity like we saw in the late '90s. If you remember the late '90s, growth was much more what someone would call inclusive, household incomes were growing up 10% across the income distribution. The nature of the job change we are seeing continues to put a greater reward on certain skills and certain educational backgrounds. That's global in nature. I don't see that falling anytime soon. That is the biggest concern I have. Rather than the rate of growth it's the distribution around the growth.

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