President and Chief Investment Officer, The Vanguard Group, Inc.
'Bloomberg Real Yield': Vanguard CIO Greg Davis
Oct.10 -- Vanguard CIO Greg Davis discusses the effect of President Trump's Covid-19 diagnosis on the economy, Treasuries, and the role of a balanced portfolio. He speaks with Bloomberg's Jonathan Ferro on "Bloomberg Real Yield." (This interview aired on October 2, 2020.)
Transcript (15 segments)
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Interviewer0:11
From the city of London for our audience worldwide, Bloomberg Real Yield starts right now. We begin with the big issue: the president testing positive for the coronavirus. Very first thing is shocking, it's shocking news. The central issue here this morning is continuity of government. We are in a world of unusual uncertainty. This situation raises the specter of uncertainty. What does it mean for the election? What does it mean for stimulus? That's the first thing we started to think about today. Fiscal stimulus is desperately needed. This news does anything to make it even a bit more difficult. Markets are going to force the government to act here. We're definitely losing momentum. Volatility certainly elevated. It was already elevated around the November outcome. Volatility will be here to stay, whether from the president's health situation or from the payrolls report. This pandemic is still very much with us. Joining us now is Vanguard CIO Greg Davis. Greg, fantastic to get you on the show with us, sir. I've asked this question a few times today. I'll ask you to view the news breaks overnight: you wake up, you get the team together. I just wonder how you process this, when you're thinking exclusively about markets, and I want to push you into the realm of speculation about the president. We both hope the president has a speedy recovery along with the first lady. But for Greg, just walk me through for you how you and the team processed this news this morning.
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Greg Davis1:28
The biggest part is really about what's happening more broadly in terms of the pandemic, right? And ultimately, how soon will we actually get some suitable therapeutics, when will vaccine be available, and ultimately how will that translate in terms of reopening the economy and allowing business to get back to usual? And so that's going to be the key driver versus an event that happens like what we saw overnight.
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Interviewer1:50
Greg, what do you think about the degree to which consumers will engage or disengage in the coming months, given what's playing out in Europe, given the spike, the small spike I should add, that's currently developing in the United States?
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Greg Davis2:01
Well, I think when we start to see effective vaccines and therapeutics out there, which are likely to come sometime in 2021, we think that you'll start to see a broader reopening of the economy, not just in the US but in Europe. But it's really going to be one of those things that until consumers feel comfortable getting back to normal, engaging in face-to-face activities, traveling, leisure, hospitality, those types of things, it's going to still be a drag on the economy. So we still believe that this recovery is going to be relatively slow, because when you think about the implementation and the availability of the vaccine, it's typically going to go to frontline healthcare workers first, probably those who are in nursing homes, and then the older populations, and it will take some time to actually trickle through to the broader consumer universe.
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Interviewer2:48
I think what many people find difficult right now, Greg, is getting to December 31st and looking out 12 months through '21 and hoping as the year develops things get better. Right now, October 2nd, they're just trying to work through to the end of the year, and you see the volatility that started to be priced into equities. And the question we've explored week after week is what little is happening in the treasury market. Where's the protection? I just want to put together your world in fixed income with the equity side of the business that you've taken on over the last couple of years. Greg, where did you lean into just for that protection going into year end?
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Greg Davis3:24
Well, look, we always advocate for our clients that there's the need for a balanced portfolio. So although 10-year Treasuries are at 70 basis points and are expected to stay well anchored given the fact that there's no signs of inflation right now or expected to develop over the course of the next couple years, and you have a Federal Reserve that's on hold keeping interest rates at zero, we don't expect a significant repricing to happen in the Treasury market. And if you look at the research, whenever you see a significant downward move in the equity markets, when we look at the months where there's been bottom decile performance when it comes to equities, bonds still provide that balance and that support to a portfolio. So although you might not get outsized returns given where we are in rates, it still provides some balance for investors to have protection in their portfolio that they could use to ultimately rebalance back into equities at lower prices. So we still believe there's an important role for bonds to be in a portfolio even at relatively low yield.
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Interviewer4:24
Greg, when you use that term, that phrase 'a balanced portfolio,' that you and I hear quite often on Wall Street and elsewhere, the definition of that, has that changed? What it means in 2020, was it different to what it meant five, ten years ago?
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Greg Davis4:36
We still believe that the role of a balanced portfolio, and many people will say 'hey, 60/40, 60 stocks, 40 bonds' is a great way and a great place to start, but it really depends on an individual's risk tolerance and what their ultimate investing goals are. There's been a lot of speculation about how you could enhance that given where we are in terms of the interest rate environment. And so what we saw, if you go back to the global financial crisis, a lot of investors migrating out of bonds into bond-like proxies in the equity space: high dividend yielding stocks, REITs, things of that nature. But the thing you have to remember is those are still equities. And so as you're doing that migration, you're increasing the overall risk level in your portfolio. So again, we believe that investors still should have a portion of their portfolio that's in the more defensive asset classes like bonds and cash.
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Interviewer5:27
I want to talk about the cash allocation as well, Greg. A number that people throw around: cash on the sidelines, the five trillion dollars in money market funds. And I wonder, Greg, if things develop, if they get better, how much that's actually going to get drawn down and put elsewhere, put to work elsewhere? Do you think that's going to be a key feature of markets for the time being, for the people that don't have the appetite to go along the Treasury curve and feel more comfortable just staying in cash and keeping a cash-like position in the portfolio, on a bigger term, a bigger level, than maybe they would have a couple of years ago? Your thoughts on that, Greg?
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Greg Davis5:57
Yes, Jonathan, that's a really good question. Again, when you're in an environment now where you have money market funds that are basically yielding zero, and you're picking up 70 basis points when you're in a 10-year Treasury, you don't necessarily want to take on that additional interest rate risk. People are willing to forgive the potential loss of 70 basis points or so. But I think as investors become more confident about the economic recovery, they start seeing the unemployment rate continue to decline over time, and once we have a vaccine that's widely available as well as implemented, I think you will see people come off the sidelines. But again, investors have to remember that the markets are forward-looking, so when all the good news comes out, the market's already pricing much of that in, and they could have missed out on a good opportunity. So we always encourage our investors to stay fully invested but also make sure they have the adequate amount of balance and diversification.
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Interviewer6:48
So, Greg, I'd like to do two things. Let's talk about how you'd push this view through credit, and then we can talk about how you'd push this view through equity. How would you push this view through credit right now? Because so many people have come on the show with me in the last couple of days and talked about double B being the sweet spot in credit, that dividing line between investment grade and high yield just south of it. Greg, your thoughts on that? How you push it through credit right now?
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Greg Davis7:10
So we still think we're still fans of investment grade credit as well as higher quality high yield. So when you look at where valuations are from an investment grade standpoint, they're right around the median if you go back over the last 10 years or so. If you look at the high-yield space, it's closer to the 60th percentile. So we still believe that high yield is relatively fair, we think IG is relatively fair, and for a lot of investors that want to pick up incremental yield relative to what's being offered in the Treasury markets and global government markets, that investment grade and higher quality high yield still offer a good place for folks to do that, in an environment where we think the Federal Reserve and global central banks will still be very supportive of economic activity and supportive of the market. So we do believe that's a fair place for folks to take on additional risk.
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Interviewer7:57
Greg, just pair that with your equity view if you can. You have mentioned that you think equity valuations have room to run a little bit. Some people might look at the big tech players and the growth segment of the equity market and say we're looking at lofty levels already. Greg, even with the correction of the last month or so, where in equities do you like at the moment?
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Greg Davis8:18
So when we look at the equity markets, if you look at where equity risk premiums are in the US relative to the international markets, and when we look at what we call our fair value CAPE index, ultimately what we see is that the US markets at least are at the higher end of what we consider fair value. So if you look at the international markets, because of the difference in valuations and what's being priced in, we believe that the international equity markets over the next decade will probably generate better returns than what you would find in the US market. So again, it's very difficult. International equities have underperformed the US markets for the last decade or so, but going for the next decade, because of where starting valuations are, we do believe that the returns in those markets are going to be greater than what you would see in the US market, all else given.
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Interviewer9:03
Hey Greg, we'd love to get you on the show again soon. Really appreciate catching up, it's been too long. Greg Davis, thank you, sir. Let's get to the final spreadsheet with the week ahead coming up. Next week, a number of final PMI readings coming on Monday, including one from the United States. Fed Chair Jay Powell speaking on Tuesday, then it's the FOMC minutes and the vice presidential debate coming on Wednesday. On Thursday, we get another round of additional jobless claims and the ECB publishing the account from its latest policy meeting. Before I go into the weekend, I thought of course with the president and the first lady. From New York and London, this was Bloomberg Real Yield. This is Bloomberg.