Webcast replay: The 2020 economic and market outlook

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TRANSCRIPT

Rebecca Katz: Hi, I’m Rebecca Katz, and you’re watching a replay of our recent webcast, The 2020 economic and market outlook. We hope you enjoy it.

At Vanguard, we’re always working to help keep you, our community of investors, informed and on track. And there’s no one better to help us with that than Vanguard’s Global Chief Economist Joe Davis. Joe is also the global head of Vanguard Investment Strategy Group. Joe, thanks for being here again.

Joe Davis: Thank you, Rebecca. Always wonderful to be here.

Rebecca Katz: Joe and his team have just released their official 2020 economic and market outlook. It’s a comprehensive forecast that looks at economic conditions around the world, and it explains how certain trends and probabilities influence the decisions that we make here around strategic asset allocation and things you should consider.

I’ll be asking Joe about his research, but really we’re going to focus on your questions. So thanks to those of you who already submitted questions when you registered. I have them here on my paper. And I’ve been doing this for ten years, so now I have to pull out the drugstore readers to read them.

You can keep sending more questions our way, especially if you hear something you want to know more about or that you don’t understand. I’ll see those here on my computer monitor live.

Before we dive in, we have a little housekeeping. If you need technical help, it’s available by selecting the blue widget on the left. And if you’d like to read some of Vanguard’s perspectives on investing or view replays of past webcasts, just click that green Resource List widget on the right.

Joe, there was actually some news today and yesterday that I want to talk about, but before we jump in, I thought we’d take the pulse of our audience.

Joe Davis: Sounds great.

Rebecca Katz: On your screen, you should see our first polling question. And what we’d like to know from you is, “Which of the following do you think will be the most significant challenge for the U.S. economy in 2020?” Is it global unrest, trade wars or tariffs, or interest rates? So vote now, and we’ll get back to you in just a second with those results.

Not to taint the results, but I thought maybe we could start with the interest rate news that came out yesterday or maybe lack of news. The Fed kept interest rates flat. So I wanted to understand from you whether you think that’s a positive or a negative. What does that reflect?

Joe Davis: It really wasn’t a surprise, Rebecca. If we looked over the course of 2019, there was actually a remarkable shift from the Federal Reserve—and I think other central banks around the world—where this time last year, we were actually somewhat concerned that the Federal Reserve would be so emboldened to raise rates that they may raise rates to a level that would potentially even lead to a recession.

We actually came close to those sorts of odds rising above 50%, and we saw dislocations a little bit in the market in August—some market volatility. In part, because of that, we saw a market shift from the Federal Reserve. They actually started cutting rates, even more than we would have expected, certainly at the beginning of the year. That has actually helped—not the sole reason—but it’s helped stimulate the financial markets. And since that time, because we have stability and growth at the time being, I think we’re unlikely to see any temptation from the Federal Reserve to raise rates.

I think that the bar is very high for the Federal Reserve to raise rates, even though they’re at a very low level in large part because inflation still remains a little bit lower than they’d like.

Rebecca Katz: You mean even into 2020?

Joe Davis: Yes.

Rebecca Katz:  Because Carolyn in Florida asked what you think interest rates would be in 2020.

Joe Davis: Well, I think the bias for the Federal Reserve, their next move, is to cut rates rather than raise them. Although, again, I think the more likely scenario is that, for some time in 2020, they’re not doing anything.

Rebecca Katz: Okay, great. Well, let’s check in and see what concern is top of mind for our investors. We asked what would be the most significant challenge for the U.S. economy in 2020, and let’s see our results.

Most people actually think trade wars, about 60%. Not so many voted for interest rates. And about 27% chose global unrest. So let’s talk a little bit about trade wars because just before we came on here, there was a bit of news on the China front.

Joe Davis: Every day I talk about trade wars, yes.

Rebecca Katz: So can you tell us a little bit about that and how you think about that?

Joe Davis: Well, our theme to our outlook this year, for those clients who are interested in reading it, is The New Age of Uncertainty. And that’s somewhat of a profound statement because what that means and implies, from our perspective, is that investors and individuals have uncertainty with respect to the future landscape of the political environment, of the trade environment, of various policies around the world. This isn’t just the United States, but it’s in China. It’s with respect to Brexit. There’s always uncertainty in life, but that level of uncertainty is much higher than normal and one of the reasons why growth, at times, has progressed in fits and starts. And the U.S. has been disappointed in China and elsewhere.

So the biggest force of the rise in uncertainty has been with respect to trade. We were of the mindset, going back for at least three years, that there was going to be increased tensions between the United States and China, given China’s economic rise—history tells you that when you have an economic, formable power in the rise and ascendance of a potential new one. History is replete with examples of that, and so that gave us at least some sense that we were going to see some tensions at some point.

Rebecca Katz: You were right.

Joe Davis: And in my personal opinion, having done this for over 15 years, I think we’re likely to see tensions between the U.S. and China on and off for a decade.

That said, we still have concerns that we’ll have trade tensions between the U.S. and China into 2020. There’s news as of this evening, in Eastern standard time, that we may see a Phase 1 trade deal. That doesn’t terribly surprise us. What we wouldn’t want to see is further escalation of additional tariffs. And when I say that, that’s not a political statement. That’s just the economic potential, modest drags we would see, both in the U.S. as well as in China, which is generally not good news for anybody.

I think what we hopefully may see is a little bit of tranquility, but I think we’re still talking about trade tensions in various parts of the world, particularly between the U.S. and China, at this time next year.

Rebecca Katz: Okay, so a little bit of a Christmas reprieve. We shouldn’t read too much into that.

This period, or age, of uncertainty—and by the way, you can find the paper by clicking the green widget—can actually be really hard for investors to digest. So let’s again take the pulse of our audience. On your screen, you should see our second polling question, which is, “How difficult do you find it to stick to your asset allocation,” your goals basically, “and continue investing during economic or market uncertainty?” Do you find it very difficult, somewhat difficult, or not difficult at all? If you’re Vanguard investors, I might have a point of view on how you’re going to answer, but we’ll come back to those responses in just a second.

Uncertainty is hard for us personally, but you’ve done some work in your paper about what it really means. There’s actually an uncertainty index that we look at in the paper.

Joe Davis: Yes.

Rebecca Katz: Tell us more about how that impacts the economy and the markets.

Joe Davis: Again, there’s always a level of uncertainty because we’re talking about the future, right? But there’s a way that we’ve at least tried to quantify what would seem like something you can’t get your hands around. And when you do that—we have the measures that we show in the paper—what that means is that when you have levels of policy uncertainty increasing much more than normal, that tends to lead to somewhat lower-than-expected investment spending in particular. A little bit less on consumption, but it’s really around businesses making one-year-ahead, five-year-ahead investment decisions because they want to have generally some clarity if there’s going to be a return on that investment.

If there’s a great deal of uncertainty with respect to how trade or how customs may be across borders, you can imagine then, for some businesses and certain industries, that it may at least stunt the level of investment. You tend to be a little bit more conservative than normal.

I know I would be in my own personal life. I have uncertainty with respect to my job. I’m probably not going out and spending as much as I otherwise would. And so it doesn’t mean that, all else equal, we have high uncertainty that we go into recession. That’s not the case, but it’s been a stunt to growth. Our best judgment is that, although we may go up and down, it’s more likely than not that those levels will at least remain somewhat elevated, which is why we’re not as bullish as I think the financial markets are with respect to growth in 2020.

Rebecca Katz: Okay, well, let’s come back to that point. So we have our poll results in. Let’s see how our viewing audience handles this uncertainty. We asked if it’s difficult—very difficult, somewhat difficult, or not difficult—to stick with your goals and asset allocation. And because we’re Vanguard investors, we said “not difficult at all.” We stay the course. Almost 48% of people said it’s “not difficult” and 42.8% said that it’s “somewhat difficult.” Does that surprise you at all?

Joe Davis: I’d be in the “somewhat difficult” camp, maybe because I follow the markets and the economy so often. Sometimes a lot of information can be dangerous, but I’m glad to hear that not many are saying “very difficult” when it’s that uncertain. I think that going back to your plan, as you said Rebecca, is the best advice.

Rebecca Katz: We’ve received, honestly, thousands of questions from our viewers about all aspects of the economy and the markets, so we’re going to jump into them. I’m going to put the glasses on.

Tough getting older.

So our first question comes from Jean in North Carolina. Jean asks, “With low unemployment and rising wages, what is your outlook for inflation and subsequent Fed rates?” We talked a little bit about your expectation for rates but talk a little bit about inflation. We just haven’t seen very much of it.

Joe Davis: Yes, we haven’t seen it in the consumer prices on average, right? Inflation, by the official measures, roughly sum up below 2% if you strip out food and energy, slightly above that if you look at other measures.

But I’d say for the past ten years, the Federal Reserve and others have actually been really frustrated because they haven’t had inflation as high as they’d like. It hasn’t been a terrible surprise to us because I think our research showed that unemployment would have to really drop materially, perhaps below 3%, before we’d see meaningful pass-through to higher inflation through wages and the fact that technology, in a digital world, makes it a little bit more difficult to generate inflation than it did 20 or 30 years ago. We were one of the few firms to actually document that sort of relationship.

So I’d hope inflation wouldn’t fall materially this year. This year, we expected inflation to rise for a little bit and then start to recede, and that’s exactly what’s been happening.

I don’t think it’ll fall much further. I think, in fact, that we may see it just stabilize close to this 2%. That’s part of the reason why the Federal Reserve is unlikely to raise rates. In fact, a necessary condition for the Federal Reserve to raise rates will have to be a rise in inflation. The past several years, they’ve been raising rates to get ahead of a rise in inflation. I think, quite frankly, they were burned a little bit by that. So I think now what they’ll do is wait to see, materially, in the data and in the economy a little bit higher inflation in consumer prices.

Wages are another matter, in a sense that we expected a rise in wages. And you don’t necessarily have to see higher wages to have higher inflation. So that’s good news because that means the economy can continue to expand the higher that wages go.

Rebecca Katz: Yes, you’d think wages would increase because the job market’s so tight. And we keep getting great news about new jobs created.

Joe Davis: There has been. It’s been roughly 3.5% wage growth across the economy. Some wonder why it’s not higher. It’s not surprising where it is, according to our analysis, given that the level of growth isn’t as high as it used to be. But it’s positive to see, and it means that although the unemployment rate is low, there are still pockets where it could actually improve a little bit further, which is another reason why I think the Federal Reserve will be reluctant to raise rates until they see a material pickup in growth.

Rebecca Katz: We did have a question about recession. You said we didn’t tip into recession. Bill in Pennsylvania asks, “Do you see an economic downturn or a recession on the horizon?”

Joe Davis: It’s not our baseline. I wish I could say the odds are zero, but they’re not. Our theme this current year was Down but Not Out, meaning that we were going to see a material slowdown in growth in the U.S. and China, so-called growth scares. We saw that in the summer, in part because of the trade tensions.

The probability, as we best estimate, got roughly close to 50%. The bond market was starting to price in those odds; the stock market didn’t. The stock market kind of looked well beyond that. The stock market was right this year, not the bond market. But since that time, our odds have slowly been coming down. They’re roughly 25% to 30% right now.

Again, we’d love for that to be zero, but they’re not. But it wouldn’t surprise me the next few months as probabilities continue to come down further if some of the headlines—even the past two days—are right in the sense that we may get at least a Phase 1 trade deal and some stability because, all else equal, other than the trade tensions, the basic fundamentals of the U.S. economy are pretty decent. We’re growing at trend, consumer spending is solid, the labor market is tight, and the financial markets have performed extraordinarily well. So all news isn’t bad.

Rebecca Katz: Well, I do want to talk about that because your outlook for the financial markets is still positive, but it’s not super bullish. It’s not the kind of returns we’ve enjoyed.

Joe Davis: Part of that is because there have been such phenomenal returns. So I’ll take a little step back. As we were saying before we came on air, Rebecca, I remember sitting here ten years ago, but maybe it wasn’t this exact chair. If you recall, it was 2009 in the global financial crisis, and we said there was going to be a rough economic patch because the market was discounting such bad news. And there was a lot of pain out there. The unemployment rate was 10%. I had family members out of work. You know, zero interest rates, talk of negative rates, even in the U.S.

But as a firm, we were of the mindset that we were going to have fairly strong financial market returns—one of the few in the industry that saw that. This was the time when everyone was talking about the new normal. And that’s kudos to all. Vanguard investors and everyone on the webcast tonight should be patting themselves on the back because the headlines would have told you to retreat from the financial markets.

That outlook has been consistent for the past decade. The past two years, particularly this year, we’re becoming more guarded on what we see in the future returns, in large part because the returns have been even higher than we would have suggested—well above that.

This is one of the strongest financial market performances in U.S. and world history. Even the bond market this year had double-digit returns, which isn’t something we were expecting for this year. We’re not saying the financial markets are going to crater or that they’re going to have drastically negative returns. Is that possible? I do think we have to ratchet down our return expectations.

Rebecca Katz: One of our viewers just said, “I’ve been waiting for a reversion of the mean.” And this is from Gary. Thank you for the comment.

For stock returns, it didn’t happen in 2019. Shouldn’t we expect a market adjustment in the foreseeable future? Reversion of the mean, everything should come back.

Joe Davis: Yes. In all of our modeling techniques and everything, and the readers can see it in our paper, we show a graph of why the past returns have been roughly 10% and how you decompose to somewhat lower returns over the next five or ten years. We don’t project one-year returns just because we don’t have a great deal of accuracy on them.

But, yes, there’s some truth to that. It’s not just because returns were high the past ten years that they should be low the next ten years. It’s all relative to fundamentals and what the market is discounting—things such as valuations, price-to-earnings ratios, or if you’re in the bond market, interest rates.

In part, because of that, we don’t see that the stock market is drastically overvalued. This is not 1999 and the Nasdaq, other than potentially a few growth companies. This is much more like we’re above historical averages; we’re above valuations. Stock prices rose higher than the U.S. economy did this year for the second straight year, and so our future expected returns have come down. But, all else equal, the next five or ten years we do anticipate that if you invest in stocks, in a broadly diversified portfolio, you should have a higher return than bonds. And so the principles of asset allocation should hold.

The final point though is that because we’re on a frothy point in the market, that it wouldn’t shock us—in fact, the odds are tilted—to at some point in 2020 see a modest correction in the market. That doesn’t mean you should try to time it.

Rebecca Katz: Right, none of us are good at that.

Joe Davis: It just means be prepared for it. We had that in late 2018. The market reacted.

Rebecca Katz: True, right at the end of the year.

Joe Davis: Remember, you and I were trading emails, and it was almost to the point of like “this is crazy.” I had money on the side, just because of bank accounts. I put money to work there to stay invested in the markets. But I would be shocked if we didn’t have that sort of environment episode at some point this coming year.

Rebecca Katz: Right, well let’s talk longer-term forecast then. So Eleana in California asks, “What is the long-term outlook for stocks and bonds?” So how are you thinking about that? Numbers?

Joe Davis: On a globally diversified portfolio the next five to ten years, it’s roughly 5% or so for a global equity portfolio—a little bit lower if you’re just looking at U.S. equities. But we believe an investor should be globally diversified.

U.S. stock markets have outperformed any other part of the world for the past five years. It’s unlikely to continue in perpetuity, and so we still believe a globally diversified portfolio is appropriate. The expected returns are somewhat stronger overseas because those markets haven’t performed as strongly as the U.S., and so there’s a rationale for why.

For fixed income markets, a decent proxy relative to our expected returns, Vanguard investors can look on the yield to whatever fund they may be in. That’ll be generally close to our expected return for that sort of strategy.

And so if you have a balanced portfolio of 60/40, a mixture of stocks and bonds, that expected return is roughly 4% or so in the next five to ten years. If we have inflation of around 2%, that’s a real return—an after-inflation return—of 2%. Is it among the highest in U.S. history? No. But it’s actually not bad. It’ll pale in comparison to the past five or ten years, and there’s effectively no, I should never say no, but there’s only a remote possibility that we get returns over the next 5 years that we had in the past 5 or 10 and in the past 30 because initial conditions, the level of interest rates, and what the market is already pricing in for future growth are unlikely to lead to the returns of the past.

That’s just a fact. And it’s not being the bearer of bad news. I think we’re just doing a service to everyone saying if we have a reasonable return, look at that plan and then you may have to react to that.

Rebecca Katz: Yes, you do tend to get used to these high numbers and think, “Oh, it’s great.”

Joe Davis: Yes, it would be wonderful if they’d continue, but that’s unrealistic.

Rebecca Katz: We actually have a couple of questions that have just come in about the USMCA and the China deal, so both trade deals, whether or not that has already been factored into the markets.

Joe Davis: I think the MCA, or effectively the revised NAFTA agreement, and free trade between China and Mexico and the U.S. wasn’t a surprise to us. We talk a bit in our outlook—and this was before the outcomes were known—but there was a bias toward having a deal done there. And so that was already reflected.

I think if the headlines hold and we do have a Phase 1 agreement, this would be positive news. We were hoping for one, but we had less confidence. We thought it would also be just as likely that we’d see a significant delay in this.

The equity markets, the riskier parts of the fixed income markets, have been on a tear. It wouldn’t surprise me that it continues for the next several months. It would give me only the more reason for caution over the next five years, but it wouldn’t surprise me at all. I think we’ll hear a phrase such as “reflation” start to come into 2020. People will start talking about potentially an upsurge in growth because we have clarity on the trade deal. They’ll start talking potentially about maybe even a return to inflation. Some will start saying “maybe the Federal Reserve will raise interest rates” and the stock market may continue to take off.

It’s something I talked about internally with our senior leaders at Vanguard, and I may even discuss at other meetings next week. I think if it did, let’s not get carried away because last year the head fake was that we were going to have a recession. Remember the market started talking about it. It was obsessed about it.

Rebecca Katz: Oh, the yield curve inverted, which we’ll talk about.

Joe Davis: That never became our baseline. We were concerned, but we thought we’d have slowdown, but we’re not going to see that. I think we could be on the opposite end this year—that some may start talking about, “Oh, we’re going to really see a surge in growth.” It’s possible, but I think we’d need to see three things happen for that to occur.

One is we’re going to need to see China stimulate significantly, and it’s very unlikely. We talk about it in our report. It’s unlikely, like in past episodes, that we’re going to see China overstimulate their economy and see a rapid rise in growth. They’re trying to slow down in a secular way, closer to 5.5% to 6.0%. And so we’re unlikely to see that, but that would have to be one condition.

Secondly, we’d have to see stabilization in manufacturing and stability in trade. I think that we could see. That would be the second one.

And then, thirdly, we’d need to see a significant rise, another sort of policy, either cuts in monetary policy, fiscal stimulus, that could be sort of a stimulant to growth. And we’re not beating on that either, but anything’s possible I suppose.

Rebecca Katz: And just to reiterate for those of you watching, the paper we keep referring to is Vanguard’s market and economic outlook for 2020. It’s in your file. If you click the green widget, you can access it. It’s titled The New Age of Uncertainty, because of all these things aren’t quite predictable.

Joe Davis: Well, like Brexit. It’s unrest in Hong Kong. It’s the U.S.-China trade tensions, and so on and so forth. The list is long.

Rebecca Katz: Yes. Tony in Texas asks, “What are all the different sources of uncertainty that could impact the financial markets in 2020?” And we know, it’s both in the U.S. and globally.

Joe Davis: And we have an election. There’s uncertainty with every election. We had it in the U.K. We have it in the U.S. Again, there’s always some uncertainly in life. It’s only when it gets to outsize position that it can have an economic impact.

Rebecca Katz: Okay. Now we did have a question, just more of an explanatory question, asking, “Why is inflation a good thing?” Growing up, I always thought, “Oh, inflation. It’s a terrible thing. You don’t want inflation.” You think back to the ’70s. But you need a little bit.

Joe Davis: Well, the rationale I believe is that you want a little bit. And that’s why central banks, the Federal Reserve and others, they tend to target roughly 2%. There’s nothing magical about 2%. But why that is, it gives you some cushion because it’s generally tough to cut wages of individuals when you have a downturn. Many businesses, even some of us as individuals, may have fixed debt, fixed-term payments—mortgages, a bank loan, and so forth. And when you have fixed levels of debt, if you don’t have a modest rise in inflation, let’s call it “deflation,” prices are generally falling.

There are always sales at the holidays. I’m talking about a broad-based fall in prices, including wages. That’s when it gets very concerning, which is why they generally target a modest rise in inflation so you avoid those situations. You have a little cushion. Even during the global financial crisis of ten years ago, we never truly dropped to wage deflation, like cutting systematically.

Because if you do, if you have a fixed mortgage payment or rent payment of $500 a month but your wages are going down, that makes it that much harder to meet debt payments. And that sets into another chain reaction of defaulting on mortgages. We saw glimpses of this in 2008 and 2009.

That’s why when you hear in the press and you hear the Federal Reserve say, “Well, we’re targeting 2% inflation,” what they’re trying to do is avoid a situation where if you targeted lower levels, you’re always deviating around that level—up and down, just with the business cycle. You don’t want to be negative 2% or 3%. That’s where Japan has generally found itself, which is why they’ve really struggled from an economic perspective. They have high levels of debt, and they really struggled with growth.

One of the reasons why is because, to this day, most Japanese citizens don’t expect any inflation, either in their wages or in the activity. And that has generally led to subpar economic performance. So that’s the rationale to the question.

Rebecca Katz: That’s a great explanation.

Let’s talk about another uncertainty, the deficit. Chris says, “The deficit is $1.3 trillion.” We’ve talked about the deficit for many years, and you’re very concerned about it.

Joe Davis: Yes, I know, I know.

Rebecca Katz: So how is this going to impact interest rates, the economy, the markets?

Joe Davis: Listen, all else equal, when a country has a high level of debt, you should have higher interest rates, meaning bond yields. You have a lot of debt, and someone has to buy it, and so there’s a great supply. And so there should be a higher interest rate that investors demand to hold that investment.

But I said that important phrase “all else equal.” And there’s actually a very weak correlation or association between levels of debts in countries and the level of interest rates. And that’s because there are other factors that can matter. And I’m not saying that debt isn’t important and that one should just have skyrocketing levels of debt. What I’m saying is that there can be long periods of time when other factors can more than offset a high level of debt. And so you can have an environment, like we have had, which has been generally our baseline. That we can have a high level of debt in the United States—and it’s rising—and yet you can have stable or low interest rates because of other factors, including the behavior of the central bank and where they’re setting interest rates. It’s the level of inflation, which has been tough to get to 2%. It’s been that the level of interest rates in other countries, in areas, are negative. It means the U.S. market is a little bit more attractive.

It’s a little bit complicated. It can seem counterintuitive, but it’s not that debt doesn’t matter and that you can run deficits as far as the eye can see. But even in the United States, throughout our history, there’s a very poor correlation between the debt level in any period in time and our level of interest rates. We try to control as best we can those other things and think about where interest rates should be for investment strategies for our clients.

Rebecca Katz: Right, great. You may have to explain this for people who don’t know, but Kathryn in California is asking, “What are or will be the effects of the massive amount of stock buybacks that companies have made since the 2017 tax cuts?” Some people may not be familiar with what companies are doing with their cash.

Joe Davis: So any publicly traded corporation, they can do several things with their earnings. They can retain them and invest them back into the business for new workers, new capital, or plant equipment. Another thing is that they can pay dividends to their shareholders. It’s the dividend yield on any one of our equity mutual funds that we can get as investors. And then, thirdly, they can also buy back their shares or they can merge with another company—M&A activity. They can buy back shares of their own corporation or they can buy another company.

We’ve been seeing a lot of that third bucket that our client talks about. That’s generally, at the margin, led to two things. One, I think it’s one of the reasons why we’ve had somewhat disappointing investment spending in terms of economic growth. The one area of the economy that has been weaker than generally expected—it hasn’t been consumer spending—has been on the business investment side. Some of that’s uncertainty and a little may be to some of the share buyback activity.

Rebecca Katz: So is that like we’re not building factories because we’re buying back our own shares?

Joe Davis: Yes, and I’m not saying that’s wrong. It’s just how the calculus of some companies are doing. But it’s been a little bit surprising to me.

And then, secondly, it’s been a tailwind to current stock prices because, all else equal, you could argue that that’s pushed up the valuations, price to earnings, a little bit as companies are taking some stock out of this, some supply, the same way the central bank took some bonds out of the system. So I don’t know how long that will continue, but it’s been fairly strong.

Rebecca Katz: So you talked about the markets being a bit frothy.

Joe Davis: Particularly the U.S.

Rebecca Katz: Yes, and Nicole in Connecticut asks, “Do you think today’s stock market is overvalued, undervalued, fair valued?”

Joe Davis: It’s slightly overvalued. Please don’t read into that, and I hope no one is hitting sell on their investments. It’s not bubble territory. We’ve been very clear with clients.

We have a graph in the paper we referenced, Rebecca, and it shows—relative to the late ’90s when that was off the chart and that was in bubble territory—it’s a little bit above the range. And so that means you lower your return expectation a little bit and that there’s downside risk in the markets. That’s just something we have to live with.

Although I do counsel friends and family members that ask me for guidance with investments, and I say, “Listen, this isn’t the year, in 2020, to be overly aggressive relative to where you have been.”

The markets are anticipating a lot of good news. The U.S. equity market, I would argue, is anticipating economic growth, real growth, of GDP of 3% or 4%.

Rebecca Katz: Oh, that’s not what we’re calling for.

Joe Davis: Yes, it’s unlikely. I’m not saying it’s going to crater. I’m just saying there could be a period of disappointment. So I think sticking closer to the plan is reasonable.

Rebecca Katz: Now I know the answer to the next question from Michael in Pennsylvania, which is, “Is there any time that a balanced portfolio is not a prudent plan?” Especially during economic downturns or maybe when the markets are frothy.

Joe Davis: First of all, for making long-term investment decisions, you have to have what’s called a policy portfolio, a plan. What is your mixture of stocks and bonds that’ll get you to your objective?

Now, if one’s comfortable taking on some active risk relative to that long-term allocation, I’d say you’d generally want to always be invested. But some investors are comfortable taking some form of active risk. It may be in an active fund; they’re picking stocks some of which may outperform versus the market.

I’m personally comfortable at times shading slightly and only in rare times when the markets seem at very extremes, and I’m comfortable if I get it wrong. I was comfortable in the late ’90s, and I was comfortable in 2009 when the market was pricing in a great depression. I actually said I became a little bit more risk-tolerant. I actually took on more risk in 2009. I didn’t get the time right because I did so in January and I did so in February, but in an autoinvesting way. This wasn’t a market-timing way.

But other than those two periods in history, I’ve just been putting my money into my plan, and every year I revisit it. There are times, though, when I have some discretionary money that’s not in my retirement plan but it’s in my personal portfolio. That’s where I may just nibble at the margin. But this is me; this isn’t advice. This is me personally. But it’s all modest relative to the plan.

Rebecca Katz: Yes, but you’re in the business. You sit in front of Bloomberg machines all day long. Some of us just set it and forget it, and we’re happy about that.

Joe Davis: But I’m saying that I’m sticking to that plan. My broad asset allocation hasn’t changed in the past ten years, and I’ve been glad that I haven’t reacted to some of the headlines.

Rebecca Katz: That’s great.

Joe Davis: Too much information sometimes can be to your disadvantage.

Rebecca Katz: For those of us who might want a little advice or help figuring out what that long-term plan is, we have advice here at Vanguard. And if you look in that green widget, you can learn more about it.

Joe Davis: Yes.

Rebecca Katz: We have quite a number of questions coming in about Brexit. You mentioned Brexit really briefly, and we should talk a little bit about your views for the international economic outlook beyond China. So let’s talk Brexit. What would the impact be potentially for the U.S. and certainly maybe more so for Europe?

Joe Davis: It would be modest directly for the U.S. We have some trading relationships with the U.K. So first of all, what’s going to go on with Brexit is that more likely than not, we’ll have a so-called “soft” Brexit, which is an orderly one. That means the United Kingdom leaves the European Union but in a delayed way, in a somewhat orderly way.

What would be more traumatic to the markets would be if you had a disorderly Brexit. There’s not a plan; the deadline comes. And that’s been a concern.

Rebecca Katz: It looked like that was what was going to happen for a while.

Joe Davis: It looks like with the election, hopefully, that we won’t see that disorderly Brexit, but we’ll see what happens. You worry about the second-order effects. The U.K. economy would clearly be even worse off, likely be in a deeper recession. But it would be the sort of tremors it would set in the financial markets, in the same way that potentially the trade tensions have done at times. So it would be the second-order effects. But right now, that’s not our baseline, a disorderly Brexit.

Rebecca Katz: Okay, good. So let’s talk about the international economic outlook for 2020, Ray in Texas was asking. You talked a little bit about financial markets and that potentially non-U.S. would outperform. But what about the economies?

Joe Davis: The economies are mixed. Europe has been a disappointment, and it’s generally tied to the performance in the U.S. and China. Germany is one of the larger economies—clearly behind the U.S. and China—but it’s underperformed because China has been growing well below potential, and our leading indicators were suggesting weaker growth in China two years ago.

They still haven’t stabilized, which is why I think Chinese policymakers are very motivated to have a sort of Phase 1 deal. And I wouldn’t have said that a year ago, so I think we’ll likely see modest stability in China, roughly at 6%. It’s pale in comparison to where they used to be at 10% and 12%, but that’s part of their plan as they move to a more service-based, consumer-based economy.

So that means two things. One, that means we’re unlikely to see a hard landing in China where growth would materially fall. That would clearly be even potentially recessionary for the U.S. That’s not in our plan. We show the odds of that, and they’re fairly low for China. But we do have growth for the coming two years that’s lower than the past two. That’s why global growth is unlikely to accelerate significantly, and I think the markets are starting to price in that acceleration—in large part because the U.S. economy is unlikely to go 3% or 4%. And China is unlikely to grow at 7% or 8%. And only those two conditions, I think, make for sustainable global growth of something that would clearly be a positive surprise for everyone.

So it’s not bad news. I think it’s more stabilization overseas. I think that would potentially be the theme. Europe has been a disappointment. China, I think, looks to be stabilizing in 2020, but that would be positive for non-U.S. equity markets because their performance was weaker economically, in terms of the downturn this past year, than it was in the U.S.

Rebecca Katz: What about other emerging markets? It’s hard to say whether China’s still an emerging market or not.

Joe Davis: Again, all these other countries depend heavily on the contour or the direction of the U.S. and where China goes. It used to be really just the U.S. and maybe parts of Europe. It’s increasingly the U.S. and China. If we’re right in that diagnosis—that the global expansion indoors, that the U.S. and China will continue to grow—we can debate softness in the second half of the year, but that would mean that we get stabilization in other parts of the world that have been mixed. That would be generally positive for overseas markets, in the equity markets, because they had some of the biggest economic underperformance.

Rebecca Katz: Interesting. And that question was from Sean, so thank you for the question.

Wow, I hope we’re not bumming out the audience here. Terrence just asked, “Do I have to resign myself to losing 2019 gains?” So I think what you’re saying is no.

Joe Davis: No.

Rebecca Katz: We just might not experience 2019 gains at that level.

Joe Davis: No. First of all, we don’t have one-year-ahead stock market projections—we produce them, but they’re not highly valuable or accurate. We do have a decent track record of predicting five- and ten-year-out returns, not with great accuracies, never a crystal ball. But our research is grounded in published, sound research that gives us some predictability five or ten years out.

And that’s important for what is the reasonable expected return for your portfolio and your plan that you were talking about, Rebecca. And by that, we’re saying in the next five or ten years, they’re just going to be lower than where they have been and what the historical average has been. I wouldn’t call this outlook bearish. It says it’s generally a somewhat lower-return environment. For bond investors, there’s no getting out the arithmetic of the low yields, and we’re a little bit at the higher end of some of the valuation spectrum, at least in the U.S., for stocks.

What that tells me is two things. For me as an investor, that tells me for my longer-term plans, I’m going to have to stay invested in the markets because if the return is somewhat lower, I can’t afford to be out of the markets for any 6 months or 12 months because the returns are lumpy. Look at December; there were great returns. But it was really weak last December. And so you have to stay invested, and that’s what our clients have done.

All of us as clients, we’ve set the standard in the industry and we’ll continue to do that. It’s just saying the numbers you plug in—if you have that spreadsheet or with your financial advisor—of how long until retirement or how much you can spend from your portfolio, we’re just suggesting that you should plug in much lower numbers than historical averages.

And I think that’s prudent. If we get surprised on the upside like we did this year, maybe we’re surprised on the upside in 2020. I think it’s less likely and was certainly less likely in 2019. But I’m not saying that this is a despondent outlook, but let’s plan on a reasonable level. Does that make sense?

Rebecca Katz: It does. I need to go rerun those college savings calculators. We have similarly aged kids.

Joe Davis: I was doing that last week.

Rebecca Katz: That’s funny. All right, we have a lot more questions. Some of these are more educational in nature. So this question is, “Why would a market correction be considered a negative rather than a buying opportunity?” You looked at 2009 as a buying opportunity.

Joe Davis:  Yes, and we would. For us, as long-term investors, we’ve prepared for that volatility. In general, I think most investors are just sticking to the plan. They may be on autoinvestment or so forth. But yes, all else equal, if we’re long-term investors, that’s how we should be doing it. In fact, certain of our strategies, such as balanced portfolios, if you have it where it’s automatically rebalancing, you’re doing that. In periods where the stock market is down a lot, rebalancing automatically is buying stocks the day they’re down and buying bonds the day they’re down. And that, in and of itself, adds value over time.

Rebecca Katz: I think the important thing that some of your research has shown is that you really can’t time the markets and that if you missed just a couple of days over the last decade, you would have missed out on the majority of market returns.

Joe Davis: Yes, a very small percentage of the days account for the vast majority of any year’s returns because there’s usually a surprise that hits the market.

The other thing too is that, generally, there’s only a handful of companies that dictate like 30% or 40% of the entire stock market return over long periods of time. So that’s also why it’s very important to have a diversified portfolio, because it’s very difficult to know those three or four stocks that end up being the large companies. They all start small, and so that’s the lesson of being broadly diversified and looking beyond the near-term noise.

And this year we’re going to need this, I think actually more from the caution. Ten years ago we were talking about having the courage to stay invested in the markets because the news was so bad. In 2020, if I’m right, I can feel investors becoming even more confident. Returns have been really strong. Everyone is very happy. Now I think Vanguard comes in with the voice of reason to say, “Okay, we don’t want to be truly pessimistic.” We’re not. “Let’s just be a little prudent here, and let’s not get too bulled up.” But I can feel it. I can feel the animal spirits coming down from the hills, and you’re going to potentially see stories in the next two or three months of how everyone is now saying the world is great, there’s no risk, and everyone should be bulled up in the financial markets.

Rebecca Katz: Well, we actually did have a comment from one of our investors who says, “Well, maybe things are just different this time.”

And we’ve seen in the headlines that people are saying, “Wow, Australia has never been through a recession. So maybe this is just new.”

Joe Davis: Human behavior is the one thing that’s never changed. And what we see is that the marginal investor in the market—it’s not Vanguard investors—tends to panic and sell in periods of stress and then tends to overreact and get overly exposed to certain investments when recent performance has been good.

Rebecca Katz: Right.

Joe Davis: That’s why our Vanguard investment philosophy tends to outperform all others because we don’t overreact in those situations. It takes a lot of discipline, though, to do that because it goes against what the first reaction is in human behavior, which is fight or flight. And I find it difficult at times, which is why everyone should be patting themselves on the back.

Rebecca Katz: You don’t see that.

Joe Davis: No, not everyone does. If everyone did it, we actually wouldn’t have market volatility, which is the irony. So I think we have to have that mindset when we have periods of market volatility. Go right to the computer screen—where’s the plan?

I’m not saying one doesn’t make changes, but go through that logic and that calculus when you see those up days or down days.

Rebecca Katz: It’s good grounding.

Joe Davis: Yes.

Rebecca Katz: And we’ve had a couple of questions, both on registration and coming in live, about negative interest rates. So Jeff, thank you for the question and also Tim in Oregon. “Does Vanguard foresee the possibility of negative interest rates in the U.S.?”

I don’t even mathematically understand how that works. They’re paying me to keep my money in the bank?

Joe Davis: You know, in parts of Europe, they’re having negative mortgage rates, so you get paid for holding the mortgage. Let that sink in.

Rebecca Katz: Have to find that country.

Joe Davis: Let that sink in. Yes, that wouldn’t be bad. I actually think that negative interest rates are a mistake. History isn’t yet fully written as to whether they’ve been a positive or a negative. So, again, for those that don’t know, in some parts of Europe and Japan, the central bank has set modest but negative interest rates. My grad school textbooks never talked about negative interest rates.

Rebecca Katz: Right, never heard of them.

Joe Davis: There’s a history of interest rates before the Roman Empire and, all the way until today, you never saw negative interest rates. Well, we’ve seen them the past few years. But if you were already at zero, perhaps you can go modestly negative to further stimulate the economy.

I think the U.S. Federal Reserve would be very reluctant to do that because of what that may do for the operation of short-term funding markets. Also, it’s been less than clear if it’s had a major stimulative effect. You’re talking about Europe, which is still lagging the U.S. and China with economic reform. And Japan still has very poor performance.

If there’s one wild card the next two years, I wouldn’t be surprised if Japan and Europe actually back away from negative interest rates and just set them at zero. Why I’ve been a skeptic of negative interest rates is because I think it may lead to some in the markets or some consumers to start to believe that if interest rates are negative, they start to actually lower their inflation expectations, meaning they believe lower inflation in the future.

The belief central banks have had is that if you cut it to negative, people will only think of higher inflation in the future. It’s not clear, and I think it may show that it may lead some to believe, “Wow, things must be really bad if you’ve got negative rates.”

Rebecca Katz: Right.

Joe Davis: Now, again, that’s a hypothesis I have; it hasn’t been proven. But I’m a skeptic of negative interest rates. Again, anything is possible. I think it would be more likely in the U.S., when we have the next downturn, what we’ll very likely see is the Federal Reserve cut rates to zero immediately—not in gradual, incremental ways. Cut them to zero, hold them for a long period of time, and then we’d very likely see not only potentially another form of quantitative easing, which I think would have marginal benefits, we’d also very likely need to see fiscal policy. And it could very well be a coordination, unofficially or officially, between the Federal Reserve and the Treasury Department.

Rebecca Katz: Interesting.

Joe Davis: But hopefully we’re not talking about that in 2020.

Rebecca Katz: No. It doesn’t sound like we are. But we did have a viewer who wants to challenge you a little bit, Joe, on your discussion around the deficit in the federal budget. And I actually think this ties to something you just said.

James says, “You glossed over the negative aspects of a $1.3 trillion deficit in the federal budget. We’ve never experienced this level of deficit spending, when at the same time we have continued strong economic growth. So please talk about the longer-term aspects of this as seen in Italy and Greece and other countries.”

And what made me think of this is that you said sometimes there’s like a skepticism, and I think people probably view Italy and Greece a little bit different in their financial stability than they do the U.S. So maybe they’re willing to pay those lower bond rates.

Joe Davis: I appreciate the questions or the comments.

Rebecca Katz: We love to challenge Joe all the time.

Joe Davis: I know. You should see it internally. This is nothing.

But let me be crystal clear because I don’t want my comments misinterpreted. No country should just continue to increase debt into perpetuity, right? Now no one knows that magical level, but at some point a country has to service their future bond payments for all the debt they issue. And so there’s a limit.

Japan is pushing the limits of what you think a country can issue debt. Their debt to GDP, the ratio is over 250%, and they have zero interest rates. So I’m not saying some countries should follow that strategy. I’m just saying it’s unclear.

I think for countries such as Italy and Greece, the markets give them less tolerance. And Argentina can get away with less than even Italy and Greece. What I am saying is that our level of debt for the next 20 or 30 years, if the projections are right from nonpartisan agencies, at some point that will become a serious issue.

And I’ve said on this webcast—on and off for the past five or ten years, Rebecca—that longer term, it is one of the more serious and seminal issues, economic political market issues, for the next 10 or 15 years.

I have, at the same time, told investors internally and externally that it’s unlikely that we’ll see a rise in interest rates tied to our level of debt in the near term because there are other forces that are more than offsetting what high debt levels can do, meaning a higher interest rate demanded by the bond market. And they have been the level of growth, weakness in both the U.S. and abroad at times, the low level of inflation, and the Federal Reserve taking rates really low for a long period of time. That can more than offset what we’d say would be a high level of debt. We should have higher interest rate payments.

So I hope that’s a clarifying statement. And at some point in the future, we’ll have to talk a little bit more seriously about the level and the composition of our debt and relative to the level of taxes to balance those budgets. But we haven’t been doing that.

Rebecca Katz: I think we’ll be hearing a lot about that in the coming months during the election.

Joe Davis: We haven’t talked about that on either side of the political spectrum for ten years. But at some point in the future, we’ll have to talk a little bit more seriously about it.

Rebecca Katz: Okay, great. Now, I do want to come back to something that I know you’re pretty passionate about, and you touched on it just slightly when you said that some of the low inflation is due to technology and our ability to really scale and get more productivity out of people because of technologies.

Mario in Ohio, thanks for the question, asks, “Will the workforce component being replaced by automation such as robotics and artificial intelligence be able to quickly find reemployment? If not, what impact will this have on domestic and international economies?”

I know a lot of us are worried the robots are coming. You’ve talked about this in your report The Future of Work.

Joe Davis: Yes, automation.

Rebecca Katz: So what do you think the impacts of that will be? What does it actually look like?

Joe Davis: There will be impacts, Rebecca. They’re not all negative. In that research, we looked at how the nature of technology will change. We looked at the threat of automation because there are some out there saying as many as 50% of the jobs in the United States could be automated in the next several years. So let that sink in.

Rebecca Katz: Wow.

Joe Davis: If you thought that was bad for the United States, how about 70% in China. Yes, that’s what caught my attention—hence, why we did the research—because that makes some of the other headlines almost trivial by comparison.

What our research found, however—and some of the silver lining—is that most jobs, most occupations, your occupation, mine, and perhaps many on the call tonight, many of our occupations have changed markedly over the past ten years. And jobs generally don’t get automated the way tasks do; most jobs are a function of multiple tasks—engaging with stakeholders, doing empirical analysis, answering the phones, talking with clients. We talk about that in the analysis.

So what does that mean “the rise of technology”? Our diagnosis for the next several years is that we’ll live in what we call a paradox. We have increased headlines around automation; we’ll tend to see jobs changing more and more the next decade—that’s extremely like to occur.

At the same time, we may have an irony for the next several years where in some markets we’ll actually have labor shortages. And that wouldn’t seem to live in the same world. It’s because, in certain industries, there’s a critical shortage of the skills needed as technology has changed markedly.

We identify roughly 10% to 20% of the occupations will see the average number of jobs come down. Their tasks will change to such a degree that there will be fewer workers needed in those professions. However, 70% of the occupations—the number of jobs today across the U.S. economy in those occupations—is likely to be higher ten years from now than lower. But it will change the nature of work and the nature of the skills needed.

My biggest concern is the demand it will place on workers to retrain over the next ten years as well as the ability to educate the new workers coming in through the system and the firm’s ability to retrain workers, generally speaking, in the next ten years. I think that’s the bigger challenge, but it’s not because all jobs will be going away. But the nature of work is fundamentally changing.

Quite frankly, I hope it does because—although it may not be pleasant going through it—as we all become more productive, that’s what historically leads to higher wage growth and higher, broader economic growth, which leads to higher living standards. So I’m actually hoping we have some of that.

Rebecca Katz: It’s a different kind of industrial revolution.

Joe Davis: If we don’t, then our economic fade is that of Japan, which is one of zero growth. And none of us want that future.

Rebecca Katz: Okay, a different silver lining on that. All right, we only have a couple of minutes left, so we’re going to try to do lightning-round answers.

Patrick asks, “So even though inflation is very low right now,” and we’re talking about it maybe not being much higher, “would it be prudent to purchase TIPS in anticipation of higher inflation sometime in the future?”

Joe Davis: Inflation protection in terms of TIPS, it’s one of the few asset classes that isn’t richly valued because no one’s really talking about higher inflation in the future. And I think it does have a role in a broadly diversified portfolio.

You’d think of it as part of your broad fixed income exposure. You have to think about asset location with respect to Treasury Inflation-Protected Securities. But if you look at Vanguard, our multiasset portfolios, stock/bond portfolios, many of them often have TIPS as a percentage of that allocation.

Rebecca Katz: Okay, great. That was a good lightning-round answer. I don’t know if you’ve read this one, but Ashok is asking, “What is your take on a CNN article that ran recently, ‘Why the Fed may need to slash rates to zero before the end of 2020.’” You don’t see that happening before the end of 2020.

Joe Davis: No. If they would, it would be because recession becomes very high odds. But that’s certainly not our baseline.

Yes, that would be something that clearly we aren’t talking about right now.

Rebecca Katz: Okay, great. And I think we should end it here because we can come back and ask the same question next year.

Sherry in Oregon says, “Please tell us how last year’s economic market outlook compared to what actually occurred.” So did you guys get it right?

Joe Davis: Yes, and it’s funny because I just shared this with Tim Buckley, our CEO, and Greg Davis, our CIO, because I think it’s always good discipline to go through that process.

So I’ll tell you, on our longer-term diagnosis of the global economy, I think we’ve done a really good job. Then I’ll get to what we missed. We’ve diagnosed in terms of duality of the future of innovation and what that means for the labor market. We’ve diagnosed the level of interest rates and inflation on average and where they’ve been, that they haven’t been rising, despite all the other things in the world. And for the past decade or so, since we’ve been doing this for ten years, we were really good in the long-term capital market or financial market outlook.

For this current year, 2019, I think we did better than most firms—actually one of the best in terms of our diagnosis for economic growth. The theme of last year was Down but Not Out. We were going to decelerate significantly for a time and get growth scares in the U.S. and China, but we weren’t going to fall into recession.

Generally speaking, we did that. We did a really good job on inflation. We said it would rise for a time, but it would peter and generally fail to hit 2%. That was good.

Where we missed is in part because of the “down but not out.” We didn’t foresee the Federal Reserve cutting, mid-cycle, 75 basis points. The recession odds even got priced a little bit more than we were worried about. And so I told Tim and Greg, I put us there as a miss.

And then, finally, although we don’t forecast one-year returns, we certainly weren’t talking 22% or 25%.

Rebecca Katz: This is why we don’t, and we don’t encourage anyone to do that.

Joe Davis: We could very well still be writing our ten-year return outlook because returns go up and down. But, yes, I put that as an X. And it’s a good X because I feel better about my own portfolio. But it wasn’t something we were foreseeing, which is just another lesson that when you read our outlook, when we talk about the financial markets, just look at the long-run returns. And then put that into your calculators. I wouldn’t use it as a short-term shopping guide—this-is-the-next-fund-I’m-buying-for-2020 sort of holiday list. I wouldn’t use it that way.

Rebecca Katz: That’s great. Well, Joe, we always take the long term. I think that’s the right approach. So thank you. We covered a ton of ground. The hour flew by, so hopefully we’ll have you back soon.

Joe Davis: Yes, thank you.

Rebecca Katz: And thank you too, members of our Vanguard community, for tuning into our webcast tonight. We do just need a couple more seconds of your time. We’d be really grateful if you’d click the red Survey widget. It’s a little survey. We’d like to know what worked about this webcast, what didn’t work? We have another one coming up in early January with our chief investment officer and our CEO, so give us some ideas for things for me to ask them. And in a few weeks, we’ll send you an email with a link to a replay of this webcast and a transcript so you can read it at your convenience.

Now let’s keep this conversation going. You can connect with us, keep asking Joe some more hard questions on Facebook, facebook.com/vanguard, or Tweet at us by going to @Vanguard_Group, and I’ll chase him up the hallway and get answers.

Joe Davis: Yes, send them. Send them in. Please do.

Rebecca Katz: So from all of us here in Valley Forge, that’s it for tonight. On behalf of Joe and all of us here at Vanguard, we wish you and your families a very happy holiday season and good health, happiness and, of course, investing success in the new year. We’ll see you next time.

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