Two months after his first macro update on the COVID-19 environment, Dr. Brian Jacobsen, Senior Investment Strategist for the Multi-Asset Solutions team at Wells Fargo Asset Management, provides his current thoughts on policy response, the economy, and having a constructive mindset during these challenging times.
John Natale: I’m John Natale, and you are listening to the podcast On the Trading Desk®. Today, we’ll discuss a range of macro topics, including the coronavirus pandemic, its ongoing economic effects, and the government efforts to steer the global economy toward recovery. Our guest is Dr. Brian Jacobsen, Senior Investment Strategist for the Multi-Asset Solutions team at Wells Fargo Asset Management. Brian, welcome back to On the Trading Desk.
Brian Jacobsen: Oh, it’s great to be back here. Thank you.
John: So we last spoke in April, which seems like ten lifetimes ago but not that long, and you joined us for an episode about the pandemic and we were perhaps a couple months into its economic impact.
At that point in time, there were just so many unknowns, not only in how the world could address the coronavirus itself, but how policymakers and central banks could support a global economy under severe strain. So can you please provide your take on the policy response thus far?
Brian: It’s interesting. When we last spoke back in April, there were a lot of unknowns, and I don’t think that the number of unknowns have necessarily diminished all that much.
One of the unknowns that has gone away is the timing of when economic activity would resume again, at least in some capacity. So since then we have seen a number of states, a number of countries begin to reopen their economies, and I think that investors right now are dealing with sort of a new unknown about whether or not the reopening was done too soon, maybe done a little bit too quickly, a little bit too aggressively.
In some of the areas of the world in which they’ve reopened the economies, you see a continued decline in new cases of the coronavirus, but in others, you see an increase. And so it is kind of interesting as far as to see the different patterns emerging, the different experiments that are taking place.
In fact, from a policy perspective, I think that’s what policymakers are still wrestling with are these massive unknowns. Central bankers have effectively said there’s a lot of uncertainty here. It’s very difficult to make forecasts. To paraphrase the great Yogi Berra, who you said it’s difficult to forecast, especially about the future. Well, especially so now, but they’re doing their best, and it seems like if their baseline scenarios are correct about economies effectively shrinking anywhere from, let’s say, 5% to 10%—that is quite a big range—but if you have that decline in economic activity, it seems like the monetary support, both in terms of pushing interest rates lower, trying to keep credit flowing in the economies, coupled with the fiscal support, especially payments to households to tide them over until they can get back to work, and some subsidies to businesses, credit guarantees, trying to also support the healthcare system, it seems like those policy responses have been proportionate to the problem to date.
Now that means that if there is another series of lockdowns or if there’s some other shock that hits the economies as we try to recover, additional policy responses may be necessary.
John: Interesting. Revisiting the wise words of Yogi Berra, let’s paraphrase him again: If you see a fork in the road, take it. So in light of that, what appears to be next on the global policy agenda for economic stimulus, because there are a lot of different forks in the road with different avenues to take?
Brian: I really love that quote, right? Because if there’s a fork in the road, it doesn’t tell you which fork to go down. And I think that’s so critical here for policymakers to keep their options open, and I think that’s what central bankers are trying to do this far as being adaptable.
Chair Powell at the most recent FOMC meeting, so the Federal Open Market Committee meeting, that they had, kind of said that there are different things on the table for them to consider, and so they’re not going to rule out anything necessarily. Although, he did say that they’re not even thinking about thinking about hiking rates right now, so it seems like he’s trying to give really good guidance about their plan to keep rates incredibly low for a long period of time until the coast is clear.
European Central Bank has talked about trying to be flexible, so has the Bank of Japan. And one of the things that we’ve seen on the fiscal side of things, which tends to be a lot slower moving, is that they were actually rather quick in responding to the problem of the pandemic. And I think that it makes people hopeful that if things turn south that maybe on the fiscal policy side of things that they will also be quick to react.
So when it comes to what’s next on the global policy agenda, I think we don’t necessarily know, but they’re trying to keep their options open and that they’re not going to likely be paralyzed in fear or in indecision if some additional support is indeed needed.
John: Thank you for providing that outlook. While we’re on the topic of outlooks, let’s talk more about the Federal Reserve’s policymaking arm, the Federal Open Market Committee. You mentioned some viewpoints from Chair Powell, but this most recent meeting was also significant because the Fed released its economic projections for a future that, of course, is so hard to forecast? What were some of your key takeaways from what the Fed has published?
Brian: So they provided their summary of economic projections, sometimes called the SEPs, and they didn’t do it back in March, so the last time that they provided these were in December. They took a pass in March because of all the uncertainty, so that didn’t make sense to provide a projection when you can’t even see in front of you. But now I guess they think the coast is a little bit more clear. There’s a bit more visibility.
So they’re projecting that for 2020 that real gross domestic product will fall by about 6.5%, but then looking ahead to 2021, to get some recovery, a recovery of about 5%. Now what that kind of implies is if for the entire calendar year, you have a 6.5% decline in activity, it seems like it’s actually projecting a bit of a big bounce in the second half of the year, so beginning in the third quarter and going through the fourth quarter. Some people might call that like a V-shaped kind of recovery. It goes down very abruptly, but also goes up abruptly. So it seems like maybe the Fed is trying to project a little bit of optimism there.
And then in terms of the unemployment rate, we know that right now were close to anywhere from 13% to 16% unemployment, depends upon how you calculate it, how people classify themselves. The real rate is probably something closer to about 16%, and even with that, the Fed is expecting that we’re going to get below 10% unemployment by the end of the year, and with this against the backdrop of very low inflation.
So they’re still expecting that we’re going to have inflation of around 1%. And what that means is that at least according to their projections, they expect that they can keep interest rates about where they are now, very close to 0%, for 2020 and 2021. And in fact, when they provide what’s called their dot plot, which indicates the kind of expectation of where the rates should be for every year, it seems like nobody’s really considering hiking rates until probably the end of 2022.
So they’re trying to convey a little bit of optimism but also being realistic, saying that they’re not going to even hint at hiking until there’s a lot more clarity around what this economic recovery is going to look like.
John: And while we’re on the topic of being realistic, I’m thinking about that path toward economic recovery and, of course, putting my risk-monitoring hat on, because there’s so many facets of risk between now and various phases of the recovery. So can you share your thoughts on those various forms of risk and how we might address them?
Brian: I think that there’s two key risks to keep an eye on.
The first is related to the virus itself, whether or not now that economies are beginning to reopen, are we going to have to backtrack on that because the number of new cases begins to accelerate? That is likely going to be a function of hospital capacity.
One of the reasons why there were the stay-at-home orders, the safer-at-home orders was to try to assure ourselves that the hospital system wouldn’t get overwhelmed. So even if we do see an increase in the number of new cases of the coronavirus, a key thing to watch is hospital capacity, because I think policymakers are going to want to make sure that people who need treatment are going to be able to get treatment.
So even though that is a risk that we could backtrack on some of these reopenings, our best guess is that if there is a backtracking, it’s not going to be as broad-based as the initial shutdowns were. That was a rather blunt and broad approach to dealing with that hospital capacity issue. What is likely to happen is much more targeted, where if there’s a particular geography that’s being affected, maybe policies can be put in place to maybe deal with it in a much more targeted way. So a risk is that there could be some backtracking, but we don’t think it’s going to be as severe as the initial shutdowns were.
The second risk is, I think, around international relations. There is some debate and disagreement about the role of the Chinese government in trying to contain the virus initially with its outbreak and what does that mean for the dispute between, say, President Trump and President Xi in China about who’s going to take responsibility and does that mean anything from a trade war perspective? Keep in mind, towards the end of 2018 and throughout 2019, the manufacturing sector, in our view, went into a recession because of the trade war between the U.S. and China and so is that now going to start heating up.
John: Agreed. I’m thinking about the risk and the rhetoric and the jarring impact it can have on the overall investor mindset. When you and I spoke in April, you discussed for our podcast listeners the need for what we call mental resiliency in unprecedented times as a way to deal with uncertainty and volatility. Two months later, can you share some thoughts on how to maintain a constructive mindset when it comes to the markets and investing?
Brian: I think that a constructive mindset doesn’t mean always being hopeful, right? It also doesn’t mean always being in despair, because I think there’s this old adage about hope is not an investing strategy. Well, neither is despair. That’s also not an investing strategy.
To have a constructive mindset is about, depending upon what happens with the markets, ask yourself: Have your financial goals changed? Has your timeframe changed? Have the constraints that you face changed, as far as you know, like aout the payments that you’re trying to fund with your portfolio in the future? Has your risk tolerance changed? So maybe a good first step is to do a little introspection about asking about those goals, constraints, and risk tolerance, and whether those have changed on any given day, depending upon what happens with the market.
If it hasn’t, then it’s maybe a good opportunity to think about okay, well, given changes in market prices, has that conveyed any new information to me about prospective risk and return opportunities? If the answer is no to both of those, then it probably is helpful to remember the old adage about this too shall pass, as far as different movements of the markets. The ups and the downs, right? That it’s sometimes difficult to remember that if you have a down day in the market that, well, maybe that could just be noise if it’s not actually conveying to you any new information. Just like if you have a major run-up in the market, well, that also could possibly be noise if it’s not conveying to you any new information about the outlook.
So in terms of the mental resiliency, I think just getting into that habit of maybe taking that step back, trying not to react but to maybe do some of that thinking around personally have your financial goals, constraints, and your individual risk tolerance changed? Has the outlook changed? And then act on the basis of that type of thinking as opposed to just reacting to whatever it is that the market is doing can really help build a more resilient portfolio.
John: I appreciate that insight. Well, it’s been great speaking with you Brian. As always, thank you for taking the time and joining us on this podcast. It’s been great having you here.
Brian: Oh, it’s been wonderful to be back. Thank you.
John: Indeed. So that wraps up this episode of On the Trading Desk podcast. If you would like to read Brian Jacobsen’s weekly blog posts, you can, of course, visit our blog AdvantageVoice®, one word, the official blog of Wells Fargo Asset Management. Each Friday, Brian publishes a series of thoughts on the week that we just experienced and the week ahead. So we encourage you to check it out. So to our listeners, thank you for taking the time to listen. Time remains to be precious these days and we appreciate you joining us. So until next time, I’m John Natale; be well.
CFA® and Chartered Financial Analyst® are trademarks owned by CFA Institute.