Top Investors' Talk: Vanguard CIO Greg Davis

Where am I getting it today? Hi Ivan, and thank you for the time today. You're catching me bright and early here on the East Coast of the United States at Vanguard's Pennsylvania headquarters, which is outside of Philadelphia.

It's a really good question, Ivan. Look, the markets are volatile, and we saw this with housing during the global financial crisis. But what we haven't seen is those spillover effects when it comes to GameStop or Archegos. But you know, the probabilities of potential risks to financial stability are low at this point, and that's primarily due to the fact that we've had so much capital set aside at the banks to make sure that they are hard enough. We've also benefited, and this has been a benefit in the United States as well as around the globe, that there's been tremendous monetary and fiscal policy supports, and that's really helped provide any significant disruption to the market or further disruption to the economy.

Are clearly rising. But in the near term, we see it driven by two major factors which are positive for investors. First, there's the base effects, but we're also seeing strong recovery and higher growth. But our research ultimately shows that inflation expectations have a bit of a feedback loop with realized inflation. So when you start to see real inflation and people start expecting more and more inflation, that's when inflation expectations start to pick up. Most folks have really strong confidence that to the extent that inflation were to rise, the central banks have the right tools and procedures in place to be able to offset a rise of inflation by being more restrictive when it comes to monetary policy. So we don't see it as a significant risk. We do believe that inflation expectations and inflation will rise slightly, but not to a major extent.

That is correct. But we also see some concern about the scale of the support. We saw last month $1.9 trillion support. Now we also will see the two to three trillion infrastructure package, the long-term one. So what will that mean to the market, to the investors? Clearly, more fiscal spending can act to raise inflation expectations, which over time will flow through to prices. But it really depends on the type of fiscal spending. We see stimulus spending as less likely to drive inflation since it's filling a gap in the economy and it tends to be transitory by nature. The other thing you have to remember is that when you have a large infrastructure plan, the reality is it takes many years to get that plan put in place. The expectation is that this infrastructure plan could take up to 10 years to be fully implemented, with at least three to four years before any of the first money gets put to work. So the belief that that could cause a significant amount of inflation in the short run, we think is a bit overstated.

We have an economy that's a global economy that's been hurting, right? But we're still trying to work our way through the pandemic. There's still a lot of uncertainty out there. And you look at what's been happening: much of that stimulus, at least from a fiscal standpoint, a lot of it has been saved. So people are becoming more conservative, and you're not going to see a big rise in inflation. I think many folks, because of the great amount of uncertainty that still exists, have been saving some of that money or paying down debt versus going out and spending it.

We have unbelievably low interest rates. As long as you have economic growth that's greater than the level of interest that you're paying, you can grow out of that burden over time. So those are the key things. But if you're in an environment where the economy is growing slowly and you continue to issue a significant amount of debt, eventually that would be problematic. So there is a point where there's a tipping point, but it's unclear exactly where that point is. Eventually, there is a bill that's due to be paid. It's just a question of when does that happen.

Sure, sure. I mean, look, since that last conversation, the U.S. equity market has become even more overvalued than it was during that conversation. So I would say it has gotten further and further away from that fair value that we would describe. And it's not surprising that in a period of low interest rates, you would expect that P/E ratio would be higher. Now what I would say is that although we think that U.S. equities are a touch overvalued, there are places specifically outside of the U.S. So if you start looking at the international equity markets, they seem to be valued more attractively than the U.S. markets. And even if you were to dive deeper into the U.S. markets, if you take a comparison between value stocks versus growth stocks, our view is that value stocks... We see the rotation from value stocks to growth stocks recently. Will that break the multi-year trend of the outperformance of value stocks versus growth stocks? That's the million-dollar question. Our research suggests that the fair value of the value-growth index is well above current levels. As such, we think that value could outperform growth over the next five to ten years. Our model is based on macro fundamentals. Growth has outperformed so significantly over the last decade that it's created a pretty significant valuation difference between growth and value, and that ultimately should lead to sowing the seeds for value's return and ultimately outperforming growth over the next five to ten years. But it's always very difficult to time these things.

We tend not to comment on individual stocks per se. We're more index managers, and we do quant investing too. But the point is that there are many times in history when you look back that companies' individual stocks have deviated away from fundamentals. But they can deviate away from fundamentals for very long periods of time. So again, what we try to encourage investors is that it's very difficult to trade and make money by buying individual stocks. Investors should be looking more at the broader base markets in a portfolio context and keeping in mind that they're investing for potentially decades versus what's happening in an individual stock over one week, one month, or one year period of time.

Over the past year, we have a joint venture with the Ant Group, and Vanguard has gained valuable insight into the size and scope of the demand for investment advisory services among individual investors in China. Based on Vanguard's research findings and what the company knows today, we see a clear opportunity to meet the growing demand by focusing on our joint venture with Ant. That joint venture is providing us with a way to get to more Chinese investors than we could on a standalone basis. So that's really going to be our primary area of focus, at least for the next number of years.

It's a really good question. Part of it is going to be the evolution of how distribution works in the Chinese market, and at what point investors become more comfortable going directly to a service provider like Vanguard to buy mutual funds and services directly from us versus going through other intermediaries in the marketplace. And if you think about Vanguard's history, Vanguard does not pay for distribution. So ultimately, we try to lower our cost to serve our clients by going directly to our clients. So to the extent there are more intermediaries involved, that creates higher costs. And to the extent as the Chinese market starts to evolve and that becomes a more prevalent way of doing business, we think there'll be a bigger role for Vanguard. But when that happens, it's difficult for us to determine at this point in time.