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Female Speaker: Please welcome to the stage our host Seeking Alpha’s Head of Quantitative Strategy, Steven Cress, in conversation with KPMG U.S.’s Senior Economist, Kenneth Kim; Invesco’s Chief Global Market Strategist, Kristina Hooper; and Principal Asset Management CEO, Kamal Bhatia.
Steven Cress: Well, great. Thank you so much for everybody for attending our summit today. It’s wonderful to have you, and we have a terrific panel here. I think we’re going to have a discussion that will provide a lot of insight for the remainder of this year, or perhaps going into next year as well.
I’d like to sort of lay the foundation for the questions just to sort of give a recap on what got us to the point of where we are right now. And 2023, in a way, I feel like it was a very misleading year. You had the S&P 500 up, close to 25%, but it certainly did not reflect the broader market. What we actually found for 2023 so when you look at the median return for the S&P 500, it was negative 16%. So very, very different than the return that we saw on the market cap weighted S&P 500.
Of course, as you’re aware, we had the Magnificent 7 last year up on average about a 110%. So carrying forward into the first half of this year, the Magnificent 7 didn’t really keep up the pace that it had last year with the exception of NVIDIA, which is up tremendous this year. I think it’s representing about 35% of the return of the overall S&P 500 year-to-date. So it’s kind of come down to sort of one stock that’s taking the market up, and it brings us into a position like, really, where is the economy at this point?
So I’m going to start off with our CEO from Principal. I think you’re in an excellent place to start this conversation. Your company has billions and billions as asset. So I believe you’re the 23rd largest in the world in terms of AUM, with a very, very diverse product line, internationally, fixed income equities. So as you look at all the assets and the products that you have, and your client base, if you were to follow the money to this point, where do you see investors going? Is it reactive, or are they being proactive trying to place themselves for the remainder of this year, or are they reacting to the events that happened? Thank you.
Kamal Bhatia: Sure. So first of all, Steven, this is my first-time here. I’m quite impressed. This is a packed room here. So, great to see this. So just to tee off where your question started. So we are about, $709 billion in AUM, about $1.6 trillion in AUA as Principal Financial Group. But probably more interestingly, in our business, the investment management business, we have clients in over 80 countries. So there’s not one uniform answer to the question you’re raising.
But I’ll tee off where you first went, are investors reactive or proactive? I think over the last few years, we have definitely seen investors get more proactive. Proactive in two ways. One, I think investors have become a lot more focused on what is happening tactically across asset classes. Probably the biggest change I have seen is, is investors look to both public and private markets to inform each other. So the way I think about it is, is the best investors in the world carry a 360 view of the world. It used to be historically stock investors wanted to understand different kind of stocks. Fixed income investors looked at just debt. But I think the biggest change I’ve seen is most smart investors want to look at debt and equity, for whether it’s a corporation or a company. They want to look at peers on the private side and the public side to inform relative value. And I think that’s probably been the biggest change in — from my seat of, well, how clients think about it.
The other piece I would highlight for you is, I think you gave us statistics on market returns. Overall, interest in risk assets around the world has continued to go up, stocks being the primary example of that. But we have seen an abnormal period where there has been a lot of money in cash, which continues to now, kind of, rethink the role of cash vis-a-vis fixed income, that would probably be the second point I would make as a CEO of what I’ve seen investors do.
Steven Cress: Well, I think it’s a perfect segue into my next question. Historically, for many registered investment advisers, for many individuals, they follow the guidance of the 60-40 rule. And that 60-40 rule clearly has not worked over, maybe even the last five years. Perhaps a lot of capital that was in bonds made its way to cash, maybe into equities. At this point, do you believe that investors will go back to the 60-40 rule, or do you think that’s history?
Kamal Bhatia: It’s a great question. So one, I would say diversification still works. I think the question you’re raising is, the difference between risk seeking, and lower wall assets, which historically bonds were. I think the nature of fixed income has changed, which is where bonds were. So I think the nature of 60-40 is probably changing, going back to the first point I made is, there has been growth in areas like private credit, which do not get counted in that framework today, but they are part of your credit or fixed income portfolio.
So I think there is a reinvention of the 60-40 idea, but I would say diversification still works. Maybe it doesn’t work in the legacy construct. I certainly see it. We are a big investor in real assets, and I see it in that area is that that same concept of 60-40 works in the real asset area. So maybe it’s changed depending on the sector you look at.
Steven Cress: And this question is going to be — it could be a little bit different, but we have noticed in the last year, obviously, many stocks have done well on the back of AI, but it’s becoming a practicality in many, many industries. And, I actually saw a survey between Microsoft and LinkedIn, which took a generational look. And even the baby boomers, such as myself, 75% of them were bringing AI to work. With your portfolio managers, obviously, they have mandates that are incentivized and prospectuses. There are lot of AI web service — stock picking services that are coming up and a lot of AI — former Quants that have developed AI and are going to institutions and, basically, as data vendors would be soliciting business, they’re soliciting the business of major institutions and introducing AI to the portfolio managers. Is this taking place at, your company? Do you — or do you envision it will be taking place or will not take place at all?
Kamal Bhatia: So AI obviously is transformational across society. From our seat, I would say probably the bigger use of AI is happening more on the client front rather than the investment professional front. And I think this thing — this will probably go in waves. But I think the biggest reason if you look at AI applications today, they really — obviously, they rely on data, but they probably rely in a simplistic way more on words than numbers today.
And I think the way you want to think about it is, if you can increase productivity by looking at large volume of words and help you use that information more efficiently like we do, in some parts of our client segment. I think that’s the first set of application. Over time, other parts of our business will start looking at it. Today on the investment side, I think the simplest example I could give you is, if you’re looking at large number of research reports with a lot of words on it, you could certainly use some of these tools to get a summary. But you still have to analyze it. I don’t think so you turn over the fundamental part of investment analysis over to a machine just yet, that’s our view of the problem.
Steven Cress: Well, thank you very much. So, Kristina, this brings us to you. So as a strategist, looking at what you expected for the market for 2023, I’m not sure, if it panned out exactly the way you thought, or if you just sort of had to move the time frame on it. But I was wondering if you could give us a little insight into your view currently. And if you did have to make an adjustment to your view, what was it and, where do you feel we go from here?
Kristina Hooper: Well, first of all, I should start by saying that it is such a pleasure and a privilege to be here with all of you. To your question, Steve, I think it’s important to go back to 2022. I would like to, you know, I have often described it as, to take a phrase from Queen Elizabeth, the annus horribilis for investors, and that we saw stocks go down, we saw fixed income go down. So it made sense that 2023 would be better than 2022, right? But what we’ve definitely seen is, this push and pull that has gone on as markets have waited. I mean, I think the overarching theme has been central banks have dominated markets, and it’s been a waiting game about when, number one, the Fed and other central banks would stop hiking and when they would start cutting.
And so to me, that has dominated the landscape and our expectations around what the Fed would do and what other central banks would do, certainly have shaped our expectations around what we would see in market. So, yes, you’re right. The timeline has shifted a bit. I think the Fed should have moved a bit sooner. Just as an example, if we look to’94, ‘95, that’s a period held up as, what many would like to see this time around from the Fed because the Fed was able to tighten, but avoid a recession. But back then, the Fed only waited five months between the last hike, to start cutting. This time, we’re coming on 12 months, it will be in July, that the Fed has held rates at these high levels and hasn’t cut yet.
So, all those things and the average has been about 8 months, 8.5 months between when the Fed has stopped hiking and when it has started cutting. So, certainly, that has caused some alterations in the timeline as well. But I’m confident, I believe strongly that once we get close, when a rate — when the start of rate cuts, does seem to be right around the corner, that’s when we will get a sustained broadening of the market, greater performance from small caps, better performance from cyclicals. Now we’ve seen, fits and starts with that, but it hasn’t been sustainable because the Fed continues to talk hawkish and continues to delay the start of rate cuts.
Steven Cress: So speaking to the start of rate cuts, I noticed that interest rate traders are now looking for, in September, and this is one of the highest percentages that I’ve seen in the close period, 64% of them are looking for a cut of 25 basis points. Do you think they will hit the mark with that, or do you think 64% is not convincing?
Kristina Hooper: I do think the Fed will cut in September. I’m in the camp lonely, but I’m in the camp that believes we will see two rate cuts this year. I think that everything we’re seeing in terms of progress on disinflation makes the case for that without having any weakening of the economy, even though we are seeing some signs of a weakening of the economy, which again helps make the case for the Fed starting to cut. So I absolutely believe we’ll see that in September.
Steven Cress: Thank you. Thank you. And thinking sort of beyond, just the U.S. and the markets, but still having an impact on the markets. Around the rest of the world with the G7, we’ve seen some movements with industrial policies. How do you think this plays into the economies and the markets globally and the impact on the U.S.?
Kristina Hooper: Well, actually, it’s really been fascinating to see what has happened with industrial policy. I think, certainly, in the business school classes I took, we were always told that that was the province of emerging markets economies, the vast majority of industrial policies. It certainly wasn’t something that the U.S., pursued a lot of, that’s changed. In 2023, 70% of industrial policies came from developed countries. And in fact, if we were to look at it a different way, the U.S., EU, and China were responsible for 48% of industrial policies. So I think of it as almost an extension or a more thoughtful approach than tariffs. Countries are more focused on protectionism. We’re clearly going through a phase of at least modest deglobalization, and industrial policies help countries pursue a variety of different agendas, including national security. So the thumb is on the scale, in a different way than it would be when you have tariffs.
But it certainly has been something in the United States that has driven up. I mean, it’s incredible to look at a chart of construction spending by sector. Manufacturing construction spending has gone up dramatically in the last couple of years, and that’s been driven by industrial policies, namely the CHIPS Act, the Inflation Reduction Act, as well as the Infrastructure Act. And so we’re going to continue to see, I think that trend, where countries are focused on industrial policies, and they do help provide stimulus to economies.
Steven Cress: And as a global strategist, we’ve definitely have had tensions with China over the last five years, maybe even a little bit longer. Do you think those tensions will continue, or do you think they will ease up, and will that benefit the markets?
Kristina Hooper: So I think we’ll always have some level of tensions, but I think greater cooperation, at least in some areas is likely to happen while there are tensions in other areas. So I think of it as a more surgical kind of relationship, where there will be areas where there are significant tensions and other areas, where there isn’t as much. I mean, certainly there are lot of Fortune 500 companies that want to be able to do business in China. And so I think that there’s going to be different policies pursued to help those companies sell to China. At the same time, there might be tensions in other areas.
Steven Cress: Thank you. Thank you. And lastly, following through on AI, is it something that you employ in your work with data or with language? You’re obviously probably assessing data from all over the world, as well as many research reports.
Kristina Hooper: We’ve actually been focused on how AI will change the economy as opposed to utilizing it ourselves. I’m sure we’ll get to that point, but for us, it’s about how much will AI contribute to productivity going forward, right? Is this going to be something like the ‘95 to 2005 period where we saw a nice improvement in total factor productivity? We’re very optimistic about the impact AI will have, by the way, because it’s not just the low hanging fruit. For example, you can read the McKinsey studies on call centers and how more — much more efficient they can become. But it’s far more widespread than that. In fact, GitHub did a study where it looked at the use of AI assistance for coding, and there was a 56% improvement in efficiency for those coders that utilized an AI assistant. So, I use that in my reports. So, that is to me, there are just so many different areas where we will see benefits to industries. And so for us, it’s more about how it will impact industries and how it will impact productivity. But I’m sure along the way, we’ll start utilizing it as well.
Steven Cress: And with that productivity in mind, and I think you’re the perfect person to answer this. If you were to look at history, going back to the early 1,900 and many of the technologies that have come along from the automobile to the radio, to the phone, to the mobile phone, to the Internet. There was so much fear with all those technologies coming in place that it was going to disrupt the labor force. What is your belief with AI?
Kristina Hooper: I think it will be disruptive to the labor force. And I think, having said that though it probably will take a bit more time than we anticipated. Now there are different adoption levels for different technologies, but you may recall, probably a decade ago, there was a lot of fear around driverless technology that would put truck drivers out of business. And we’ve seen, it’s taken a long time for regulators to feel comfortable, and we’re still not there with driverless cars. The idea was that Uber was just using humans, as almost a short term fix until we got to driverless cars. We haven’t gotten there yet, and I don’t see that in the near term.
So it could very well be a situation where we don’t see it having a big impact in the shorter term in terms of labor. But I think over time, it could be significant. That is where government policy comes in, in terms of retraining workers, in terms of basic income, all kinds of things. But I do think we have to envision a world in which at some point there is a significant impact to the workforce. Now it could be, the argument has been that for every job lost, two were created, for example, in an area that’s more technologically focused, that could be the case. There is, to me, a lot of potential paths right now as we look at the landscape and AI’s impact.
Steven Cress: Well, Ken, that’s a perfect lead in for you, the impact that it potentially could have on labor. Could that potentially ease some of the labor problems that we have? It’s the biggest component of inflation. Do you have any forecast with that impacting the labor force in the near term or do you think that’s more of a longer term issue?
Kenneth Kim: Sure. That’s a great question, Steven, and good morning, everyone. Great to be here. Certainly, AI and digital transformation that’ll be critical to get our GDP to go to the next level plane. So what I mean by that is, when you think about where GDP could be in the future, there’s two main components. One is the labor force component, and the other is productivity, which is diffuse through technology. We know with the labor force component, the constraint is our slowing population growth. Our population growth has been slowing for decades, household family sizes have been becoming smaller, and we are a developed economy.
We already see this happening in Italy and Japan. And that’s not to say that’s, it’s a matter of good or bad. It’s just what happens with developed economies. So knowing that, there will be a constraint on that labor force component for the coming decades, because of slowing population growth, our GDP growth has to come from technology. So, I am hopeful, that we can do that. The U.S. is the largest economy in the world, and we are the most dynamic economy in the world. We account for about 25% of global GDP. China is about 18%. So, from that standpoint, I am hopeful.
Steven Cress: Yeah. With respect to demographics, both China and the U.S. have aging populations. The baby boomers will not be around in the workforce that much longer. So, your belief is that the technology prospects that we have could actually help ease part of those issues that we face.
Kenneth Kim: Yeah. That’s exactly right. In the past couple of decades, it was the PC that helped drive productivity in the 1990s — 1980s. In the 1990s, the Internet helped boost productivity. So, this time around, it’s going to be hopefully generative AI and digital transformation, workforce upskilling, and other associated avenues.
Steven Cress: Well, I actually find that quite helpful. Thank you for sharing that. Coming back to some of the more immediate issues at hand, we were discussing the Fed and a potential rate cut coming up in September, but the Fed actually compared to some other countries, is fairly slow. I was wondering if you could share some of your thoughts in regards to other central banks throughout the world that have been leading the rate cuts.
Kenneth Kim: Sure. Well, we already know, the ECB and the Bank of Canada already started their rate cuts, two weeks ago. And for the Fed, we’re looking for one rate cut in December of this year. But our call at KPMG is not that different from Kristina’s. I think reasonable people would say September is possible. So, yeah, sure. September is possible. This morning, we did get retail sales data, for the U.S. and it did come in below expectations. And treasury markets are already rallying on that news, to 10 years below 4.30% and the two years, 4.70%. So, fixed income markets are again, itching for a rate cut.
Just going back, a few years back, you remember when the Fed, before they started their rate hikes, they talked about inflation being transitory? And it took them a while to kind of assess the inflation landscape and actually, carry out their first rate hike. Well, a year to a half year before the Fed even started raising rates in Spring of 2022 both the Banco do Brasil and Banco de México, Mexican and Brazilian central banks, they already started hiking interest rates while the Fed waited, because they knew exactly what to do when they saw inflation because of the numerous episodes that they’ve experienced with rising price pressures. So, the one thing is, the Fed didn’t take that into mind. They kind of thought inflation would be transitory, and we all know it didn’t turn out to be that way. So, I think there is a lesson to be learned from that.
Steven Cress: And what upcoming date event do you think could seal the deal for the Fed taking rates down in September? What data point would you look for?
Kenneth Kim: Well, a lot of things. This morning’s retail sales, it’s kind of, paving that way. The next, inflation report from the personal expense — consumption expenditures report later this month. Obviously, the unemployment data is always a key report at the start of every month. So talking about industrial activity, the purchasing managers index, which is seen as a leading indicator of manufacturing activity as well as services activity, the ISM manufacturing index recently went below 50 and 50 is a breakeven line. So when it goes below 50, that means, manufacturing executives believe that activity is contracting. So that is a softer signal for the economy.
Steven Cress: That definitely would be a softer signal. There outside of macro events, between September and December, there is a fairly big geopolitical event occurring, and I’m not sure if you caught early on. Ken is actually with KPMG, which is different than our other two panelists that are with Asset Management Institutions. And I think being that you’re with KPMG, your firm is probably pretty familiar with taxes. Is there a house view that your firm has on, if Trump wins the election or Biden wins the election? And, as you indicated earlier, we may not know in November. But whatever the outcome is, is there a view?
Kenneth Kim: I think the best view is, it’s still an unknown. We’re still so far away from who, which candidate may actually win. But the current administration has proposed raising the corporate tax rate back to 28% from 21%, but not all the way back to 35%, which is where it came down from, during the past administration. The former administration, they’re saying that maybe the corporate tax rate could be taken down a little bit to 20%. Although, I have heard lower numbers as well. It really depends on who wins the election and then also the makeup of Congress. So, a lot of…
Steven Cress: …a lot depends on it.
Kenneth Kim: Yeah. A lot of the congressional seats could also be up for grabs. So there’s still, I think, too much uncertainty to say which way the outcome you can handicap the tax outcome.
Steven Cress: So your firm probably is not redoing software packages yet.
Kenneth Kim: Not yet. No. There’s just too much uncertainty. It’s still far away.
Steven Cress: And Kristina, what are your thoughts on the outcome either way if we have a Trump victory or a Biden victory?
Kristina Hooper: What we’ve done is looked at history, and what it shows is that it really doesn’t matter very much who wins. Certainly, there’s a slight reward for, checks and balances. So a mixed government tends to do best. But at the end of the day, there’s not a lot of difference. In fact, I would say, the biggest concern right now on the part of many fixed income investors, or I should say, sovereign investors, is the idea that at some point, it will be unsustainable to have the kind of fiscal approach that the United States has had.
And so I think there needs to be more conversations around how we get back to a point where we have balanced budgets or get close. I mean, we haven’t had a balanced budget since the late 1990s and the debt has grown. We have, of course, response to a pandemic that has added to already a pretty significant pile of debt. Now of course, there will be pressure taken off once the Fed starts cutting rates because it’s all about, the line item, how much it’s costing the government to service that debt, and it’s high. It’s going to exceed defense spending this year. But when it goes down, it may not be as big an urgency, but I think that should be part of the conversation. But, I don’t think there’s going to be much difference in either administration.
Steven Cress: Is there any projection that you have on fiscal policy right now? Do you, is it…
Kristina Hooper: Not good.
Steven Cress: Yeah. Well, the market seems to be taking its stride. So with the election, just around the quarter, do you find any of the investors in your firm are hesitating to make any movements in terms of their allocation to equities or bonds? Do you anticipate that they’ll stay in that cash, that large amount of cash until after the election? And after the election, do you think they’ll be putting that cash to work?
Kamal Bhatia: Yeah. So I think just going back to your question on elections, I think one of the most powerful forces that has helped market is U.S. still remains the epicenter of the best companies in the world. And just innovation has been a big part of that trend. And if you look at history, political changes happen, elections happen, but the constant force has been this upward trajectory of the quality of company we create. They continue to gain more market share. So when you — when I talk to global investors, their faith in U.S. as a destination for investing is very, very strong. And it used to be with securities, but even just with the rate reset, you could see, their faith in cash or treasuries also went up.
The biggest concern I get from investors is, the unsustainable level of debt that U.S. has now. And you can look at countries outside the U.S. who have to act on that because the market doesn’t penalize them, but U.S. has gotten away with it for a very long period of time, and the big question we face as a society is, at what point will international investors not accept that and move away from U.S. investing because they do control a lot of capital that comes into the United States. So, Steven, I would say that’s the biggest risk is our fiscal situation rather than changes in politics, which are very difficult to predict generally over a long period of time.
Steven Cress: And Kristina that concern, do you see that coming to push in 2024 or 2025, or is this going to go beyond that?
Kristina Hooper: So, I’ve seen it a lot this year. I’ve probably gotten — I’ve been in the industry since 1995. I’ve probably gotten more questions this year than I ever have, and that includes the period we went through during sequestration and, the Simpson-Bowles Commission to try to reduce the deficit. There’s a real spotlight on it, on the part of a number of investors. Of course, we’re a global asset managers as well, so we are hearing from investors outside the U.S. And I do think though that quite often it’s when we get to that tipping point, when we’re spending more money on servicing debt than spending it on defense, that it becomes a real concern.
And then we wind up when pressure comes off kicking the can down the road. So I don’t know, if this really will be a different time. It’ll be different this time and people will stay focused on this, or if rates come down and people will say, okay, there’s less pressure. We won’t worry so much about it. I don’t know the answer to that, but I do think, at least for now, there will be significant talk about it and concern about how we remedy the situation. What we learn though from the Simpson-Bowles Commission, which was that bipartisan commission to try to get to a balanced budget was that, there are an awful lot of sacred cows, and there are not a lot of places to cut in the U.S. budget.
Steven Cress: Okay. So one of the things that you are more secure about is that you do believe there will be two rate cuts this year. How do you think the market reacts on the back of that? Will we be higher than where we are right now? And I do think you said, it will broaden out to small cap and industrials, but does that take the whole market higher?
Kristina Hooper: I do think so. I think we see that broadening that, that enables the entire stock market to move higher. I think we see some rallying in treasuries as a result. I think it sets us up for a positive environment. We’ve already seen sort of the discounting of that, at times, but again I think this would be when we get to the point where it’s more sustainable and we see that broader participation. Small caps, cyclicals, and I think it also benefits stocks outside the United States. European and UK equities, I think, could be significant beneficiaries. Emerging markets equities, U.K., in particular. There’s political stability there that we’re not seeing right now in Europe, at least political greater political certainty, more attractive valuations. So I think those areas could benefit as well.
Steven Cress: And Kenneth, about you. You’re looking for one cut in December. Do you think that that discounting effect between now and December will take the markets up or do you think it’ll start to flatten out?
Kenneth Kim: I think it’ll help the market because, once the rate cuts happen, there is the expectation that the Fed will do more in 2025. So, we actually have six rate cuts in 2025. So, yeah, we are expecting that will help both the economy as well as the markets going forward.
Steven Cress: All right. I’m sure not — I’m not sure that’s going to do for the 60-40, that could help it. It could put people back into bonds. Your thoughts going into the end of the year?
Kamal Bhatia: My thoughts are, I think my panel has covered it well on the rate cuts. I think to your question, look, the direction of travel for monetary policy is stable or downward. As you know, when that happens, difficult to predict. I think you raised the question of 60-40. I think duration was something people were very averse to because in an environment where we’ve had where rates have gone up rightfully so, across the world, people just were not really interested in fixed income for a long time, and it made complete sense. And I think as the world changes for a variety of reasons, there is more interest in fixed income. I think you’ll see that go up, which will certainly benefit the 60-40. I would say probably the most important thing for us as an investor is, is to understand what that does to the real economy. If the rates get cut because the economy is softening way more than one anticipated, that’s a very different scenario than rates being cut because the economy is still okay, but we had other issues we had to deal with. So it really depends on the context of how the market would react to it.
Steven Cress: Well, thank you very much. This was a wonderful panel. I really enjoyed your thoughts and the ideas that you have going forward and covering our history over the last two years. On behalf of Seeking Alpha’s client base and subscribers, thank you very much for your time today.
Kamal Bhatia: Thank you.
Steven Cress: Thank you.
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