An Entertaining Outlook of The Macro-economy



Scott Colbert

SVP & Chief Economist,
Commerce Trust Company


[0:00] Scott Colbert

The crowd can only take away so many things. And so I’m going to give you four things to take away. All right. What’s the first one we’re going to take away? What’s the first thing everyone’s talking about when you wake up other than Tesla?

[0:15] Scott Colbert

Coronavirus, right. All right. Don’t worry about it. All right.

[0:23] Scott Colbert

Second thing, it will have a modest impact, but we expect global growth to accelerate and US growth to accelerate. That is an out of the consensus forecast now because everybody says the coronavirus is going to kill us. Okay. All right. That’s, that’s the second thing. The third thing is we expect this economic recovery, which is now 10 and a half years old and the longest economic recovery we’ve ever had in the country to continue to last, a while longer, and a lot longer than the average forecast is. And then the fourth thing we’re going to finish with is stocks. You all have too many stocks probably in your 401k, they’ve gone to the moon. We’ll talk about how expensive they are and what you can do to maybe range some of those risks towards the end of the presentation. So I am trying to make this thing move forward. It was pressed downward one. There we go.

Haha, good. Alright, so this is a global growth over the last three years 2017, 2018, 2019. Now it takes a very intelligent banker to figure out what’s going on here, huh? It’s what, it’s slowing, and it’s been slowing. Why has it been slowing? Well, let’s look about, let’s think about that. These are the purchasing manager’s indexes from JPMorgan. This first one is the service manager’s purchasing index. And we all know the service economy has not been impacted nearly as much as the manufacturing economy. And in fact, the servicing economy, even though it’s been declining for about a year and a half, now almost two years consecutively around the globe. It’s still, you know, showing signs of expansion, but when you take a look at that manufacturing economy. You get this stuff here, you can see that we dip briefly below 50 and 50. It’s a diffusion index. And so theoretically that some contraction, but you know, there’s been no doubt for the last year, year and a half, two years, we’ve seen this contraction in economic activity around the globe. Now, why has it been going on? Mostly, it’s right here, that China’s slowed down. So China’s dealing with a lot of big numbers, they grow at 10%, 9%, 8%. They only grew at 6% last year, and that’s the lowest growth they’ve had since 1989. So China, you know, has slowed a bit.

[2:35] Scott Colbert

We had higher interest rates in this country, we were called with the Federal Reserve and 2018 was actually raising interest rates and they raised them four times. And so we were fighting, the net effect of that. The dollar has been increasing and you guys are treasurers and understand currency exchange. And when the dollar gets strong, the globe has a tough time. We’ll talk about why here and as we work through the thing, and then finally there was this little thing that they call the trade war, that has kind of been put to rest. But I want you to think about all this has any of it dissipated here? The Chinese are still slowing. And of course, they’re the whack with this coronavirus. So you can probably ‘x’ that off the table, the higher interest rates have largely been dealt with, haven’t they? The Federal Reserve has eased three times and they’re probably likely ease once again this year, the stronger dollar has largely peaked, although it’s really accelerated just a little bit because the virus here, and I do think that the trade war, this phase one of the trade war is really been a positive, a net positive for the country.

And while China really doesn’t have the ability right now, to do all the things that they said they wanted to do, I do think in the long run, they will attempt to work that way. So a lot of the negatives have become positives. And you can see that we’ve had this recent blip up and that’s my optimism that things can get a little better because people you say, “Colbert Look, the hell one’s going to get better.” And I said, “when that damn wind turns around”, and the winds turning around, believe it or not, and things are going to get a little bit better this year, despite the fact of having been laughed a little bit. Now, these are the length and magnitudes of our economic recoveries post World War Two, here are the eight weakest ones, but you can kind of see they all, you know, accelerate in a similar direction. This is the third-longest economic expansion we ever had. It lasted almost nine years that was back in the 60s. I was born in 1961.

In 1969, Roger Staubach was signed by the Dallas Cowboys. Okay, so that’s that’s that recovery right there. The second-longest recovery we ever had was exactly 10 years during the Clinton era if you will be bordered by the first Iraq war and ended with the internet bubble and the longest economic recovery that is this one going on right now. Now, what’s different about this longest recovery than all those other ones, what’s different? That’s a blue line, blue line. Now it’s a lower trajectory, right? Absolutely. It’s about 60%, as much oomph as we’ve had to previously. And we like to think of recovery as a lot like a runway, we had a runway right down the middle of the field here, and you’re taking off with that normal Boeing 737 on Southwest like I always seem to fly on, you know, almost you can count how long it takes to get to 140 miles an hour and lift off. Well, that’s a typical recovery. But this recovery has been more with an older plane, some Old McDonald, Douglas, MD 83 or something with the smaller jet engines, and it’s still rumbling a little bit down the runway. And because it hasn’t moved nearly as quickly as it normally does, we still think there’s quite a bit more time to use up all your what? Your plant, your capital, your equipment, your capacity to basically grow.

Now maybe we’ve used up the people part, but we are starting to pull some people back in the workforce, thank God. But other than that, there’s still quite a bit of plant and capital, not only just here in the United States, but around the world to afford us the ability to continue to grow because it’s been a lower projected path of recovery. Now what is holding us back and why was this a slower recovery than every other recovery we’ve ever had, least argue about is gonna be an L-shaped recovery, V-shaped recovery. I call it the square root recovery, it’s kind of got a little bit of a square root look to it. The three D’s, and we’re stuck with these three Ds for a long time. First off, of course, is the debt build-up that we build up here in this country, not only here, but we build it up around the globe, in terms of most developed countries that look a lot like this. At the peak, this country was borrowing 3.7 times its income. And you can think about this just like your companies, or just like a family’s income.

[6:38] Scott Colbert

The average, let’s see the net debt to earnings before interest in taxes for the high yield sector of the market right now as presented today is about 3.8, okay, 3.8. And you start to get into junk territory, typically depending on how cyclical your company is once you reach about a three times ratio. And that’s exactly what we had going on here. Because basically, since they invented the first credit card since they invented the first loan shark since they invented lowered interest rates, we’ve been willing to borrow more and more and more and more money until finally, it peaked here at about three and three-quarters times our income. Now commerce bank will loan you, no big deal. Two times your income for a house of your family, the hundred thousand dollars, 200,000 for a house, no big deal, right? We lend you $50,000 for an F 150 and a half over Honda Accord, right? We’ll give you a $25,000 credit card that’s $275,000. And maybe we’ll give you a home equity line. But once you get the three times your income, what do we do? Carlos, what do we do? We send them to Wells Fargo.

[7:50] Scott Colbert

They seem to be able to handle it pretty well, right? It’s moving away.

[7:55] Scott Colbert

But there’s the point of this is this is the first economic recovery we’ve ever had where basically we have despite the fact that the Fed brought rates to zero, and begged us to borrow more money, we refused because we had over-borrowed. And so this is why this recovery, and likely every recovery that we’re going to be facing until the Ds to get better, that would be the debt. That would be our deficit. And I’m not so sure our deficit is going to get better anytime soon as it, and the demographics. Now, this is a young crowd. But I’ve been doing this since as the bank says I’m 33 and 58. Now I’m 27. Actually, I’m 28 years into this thing. I’ve aged, I’m starting to age out, right. And so the demographics also slow the recovery because we’re more interested, folks, my age are a lot less interested in buying a new suit. And we’re more interested in saving, you know, for retirement. So the combination of the 3 Ds the debt, the deficit and demographics will force basically every recovery that we have from now on to be a lot slower and subpar relative to the recoveries that we used to have, when will it get better? When you will get better, how many years forward will it take, if it doesn’t get to get better and we start to have these 3-4% growth rates?

[9:15] Scott Colbert

Well, that would help if we do that. And then that takes 18 years or so or 15 years or so. But absolutely, if we can increase the birth rate, and it’s not happening, we can’t get the women to cooperate today, so we got to get more cooperation out there, but they’ll get the first step death rate, but it’s largely when the boomers die, it’s largely when the boomers live that leave the planet because you want your demographics to look like a pyramid. You want one person to be 110, two people will be 109, a hundred people be 100, and we got this bulge just about 64. Right around the roofline, we got a bulge around the roofline, and the walls are having a hard time holding it up. And we need that bulge that that pile of the pigments in the python to move through and get out and get back more to a demographic shaped pyramid, and then our growth rates can begin to pick up again in the future. Now, that’s the bad news. The 3 Ds is debt, deficit, demographics.

We always talk about the bad stuff we never talked about the good stuff. And the good stuff is, is that we are a lot wealthier as a country than we have ever been. Total cumulative wealth now is about essentially five-plus times GDP. We are 60% wealthier than we were prior to the peak of the last recession, adjusted for the 20% inflation. And we’re about 40% net wealthier because your homes, your pensions, the valuation of your corporations, because of all those private equity funds out there trying to buy up all those corporations, your life insurance, your savings, your house, everything has improved materially. And there is a wealth effect of this country, about three-tenths of a percent of all the wealth is created each year gets spent the next year we created $11 trillion of wealth last year, 11 trillion times point 3% is 330 billion dollars. That is about a point one five, almost two-tenths of a percent boost the GDP this year, and we didn’t have it last year. Remember what happened in the fourth quarter last year, all that wealth you thought you had disappeared when the stock market fell 20%. And so we didn’t get a boost last year. In fact, the best returning asset class last year was one, my lowly Bond Fund, and its total return was zero, not last year, the year before 2018, zero. So if you didn’t hold cash, basically, you’re lost money in 2018. But it’s a lot different this year because we have a positive wealth effect with for the first time a long time, very nice little tailwind going and at the end of the year. Now. You can never have a recession. If we are creating employment.

If you promise me that we will create just one job collectively, we will grow as a country. We will always have a recession if we are firing more people than we are hiring. It’s that simple. The day that we begin to fire people and lose jobs is the day when they go back and look at it two years later, the day that the recession started to the minute, it’s a coincident indicator. So if you can kind of guess whether or not we’re going to create jobs, I can tell you whether or not we’re going to grow the economy. Now, the good news is that we’ve been creating jobs. The bad news is, of course, that we lost so many jobs. during the recession, we lost 9 million jobs.

Compare that to the previous recession, the internet bubble, it was like it never really even happened, right. So this was the deepest and most severe contraction we’ve ever seen post the Great Depression. It was 40% longer than the average recession. And it was 60% deeper than any prior recession we’ve ever had. That’s why we felt like the world was going to end. And that’s why the recovery now it’s been so slow, but job growth has averaged, we created 20 million jobs, and we’ve averaged about 165,000 jobs created per month I’ll go back, one, one other thing. If you want to try and figure out how much we’re going to grow as an economy, all you need to do, and this is the dirty little secret, we can throw all the other stuff away. You can tell me what percent of the economy we have more jobs. And you can see here that we’re growing jobs at about 165,000. About 1.3% a year. You can tell me how much the raises are going to be and what was your raised budget this past year, huh? Who wants to give me an answer? About 3%? That’s 4.3% more money. You adjust that for inflation. Inflation is what? Two! 4.3 minus two is? And that is exactly what we grew last year. Now you’re all chief economists. And you don’t need to buy the economic models. You don’t need to sit around and think about it too much. That’s the first cut at it. And that’s exactly where economic growth so if you can promise me that we’re going to add jobs and that we’re all going to get some raises.

We will have more money to spend next year. We know that that’s about 70% of the economy. What’s the, what’s the next step? If that’s 70%? What’s next? It’s government. Now you get into 25% of the economy, and the government will spend every penny they have. And if they don’t have they spend it anyhow. Right. So that’s 95% of the economy in the last five years just hanging on about business investment, and that imports and exports. That’s what all that variable is that had 5% wiggle room is really the variability that people haggle about. Now, there’s no doubt this economic cycle has peaked. If you look at car sales, this is the first chart here. Car sales peaked, you know, the last recession they fall, they recovered. They didn’t recover on average, you know, auto sales, usually about 3.2% of GDP. They never recovered fully. If we had any auto people do we have any auto people in here, auto people, the auto business, anybody? You know, 2017 was the peak year for auto sales. And last year was a little cooler and 18 was a little cool. And 19, GM is forecasting half a million lower car sales next year. So we’re going to break from positive 17 to something probably below 17 million car sales. Car sales, it’s just simply late in the economic cycle. So many parts suppliers and all that stuff, car sales are kind of peak. So there’s no doubt they’re rolling over.

But nonetheless, we still have a question on how far we can expand. And if you look at housing down here, whoops I keep going the wrong way, sorry about that. Let me look at housing. Housing too was peaking. But we’ve had, in the fourth quarter, a little bit of a late-cycle blip here, we actually sold more houses and started more houses than we have at any time in this recovery at the end of the fourth quarter. Why? Because interest rates are 90 basis points lower, mortgage rates were 90 basis points lower than they were in the fourth quarter of 2018. So we’re getting a late-cycle surge out of housing, but it never contributed either. What it normally does, on average, because we were so overbuilt in housing, so there’s no doubt the economic cycle is peak. The question just is how much further do we have to go before we run into the brick wall that we like to call recession? So a lot of the worry last year, of course, was about China and the trade deficit. It’s kind of, you know, we don’t realize, if I asked, I do a lot of these things, and I managed some union money, Taft Hartley, money for, you know, carpenters, electricians, if I was talking to them, I asked them, how much of the economy is imported, and the origin of what percent of the GDP is imported. I get numbers that range from 50 to 75%. And, you know, we import about 15% of our goods and service. We export about 12% of our goods and services. So there’s a 3% trade deficit. 2% of that 3% is with China. And this is why the administration so focused on China, we were importing about 500 to 550 billion dollars worth of goods and services of the people in China and we were exporting about more than 100, but less than 125 billion in goods and services. And you know, between the two of them, that’s a $400 billion trade deficit. 100 billion divided by a $20 trillion economy is 2% of our economy. So 2% GDP, notice that the whole trade deficit is only $600 billion. So this is why we focused on China. But we never thought it was going to be that big a deal because of China.

[17:27] Scott Colbert

In terms of the size of their economy, they are 65% the size of our economy, we literally are almost four and a half to 5% of their economy. In other words, they’re selling we’re their largest customer 5% of the Chinese GDP is dependent upon us buying their widgets and stuff. On the other hand, what we were selling to China was less than half a percent of our GDP was about 22% of our GDP. And while it hurts General Electric and Boeing and our chipmakers and our soybean farmers, if they’re Chinese are not buying as much of our stuff. It is almost no dent to our economy to the extent that China slows its purchasing of our goods and services. And that’s why we work through this trade deficit. And that’s actually why China finally came to their senses and said, “Listen, we do need to buy some of your stuff. And we’re going to try and play a little fair.” And so this is what the administration was focused on. And, and this is why they were able to drive the Chinese feel home.

The biggest reason they’re able to drive a bargain home was, that, when you take about talk about imports and taxes on imports, if we were taxing those imports, we stopped importing them. There are total imports from China are down 14%, since they imported as soon as they started tariffs on Chinese goods and services if they put a 10% or a 15% tariff on them will find 35% less of that stuff. And if we went in with a 25% tariff, and remember, on December 15, we’re going to put 25% tariffs across the board on everything, including those iPhones in your pocket, you wouldn’t work that we were buying about half what we used to if there was a 25%, this is why China understood this, this is 2% of their GDP, if in fact, we would buy half as much stuff as we used to buy. And that’s a big slowdown to Chinese GDP. And this is why we ended up within green. Now we also talked about the strong dollar is slowing global growth. And these are the reasons that the strong dollar first off most trade is conducted in dollars and euros. Two-thirds of all trade is conducted basically in dollars and above the other third is conducted largely in euros when Pakistan trades with India. They don’t do it in rupees and whatever they do it in dollars. 40% of all debt out there is dollar-denominated. And we don’t have it all the emerging markets borrow in dollars, Russia borrows in dollars, even China borrows in dollars, and we’re the only ones with a printing press.

Well, China’s probably got a printing press. Russia’s probably got a printing press but short of those 2, probably, you know this and it’s hard for them to come up with $1 so when the dollar is strong, it slows won’t grow. We know that about a third of all currencies and almost all the emerging markets tie their currency to the US dollar. And when the dollar gets strong, it makes their exports tougher for us to buy. And then finally, all energy is trading dollars, so when 1 strengthening its tends to slow global growth. Now, we’ve been largely hoping that the dollar would peak and it’s been slow over, you know, it hasn’t been moving very much lately. And so there hasn’t been a lot of appreciation. But in general, over the last, the recovery of the US, because the US was recovering the fastest on a relative basis compared to the globe, the dollar has gotten stronger. Notice how much global growth though, moves a lot quicker when the dollar is getting weaker, and it just goes a lot slower. When the dollar is strengthened. Now the dollar rollover is largely anticipated and hope for that has yet to arrive. The reason for that largely is because what? Our interest rates here are much higher. And we still have more growth in most developed countries, despite the fact that we even lowered interest rates last year.

Now how much longer can we grow? I’ve got two charts here to talk to you about why I think we’re going to grow for quite a while. And the dates aren’t really important, but the idea is that it’s out there away. Okay. So hang in there with me. These are the leading economic indicators. There are nine of them. We told you the jobs were a coincident indicator. Can anybody give me leading into the stock market? The problem with the stock market is it gets two recessions for every one that it calls. Okay, so it gets scared twice as often as it should, the shape of the Yoker. Credit spreads. What do you do before you hire somebody at your company and create that job? What do you do with your workforce before you hire an additional boss? Maybe outsourcing labor or you work your people more overtime, right? So overtime is growing. That’s a leading indicator. If overtime declining, that’s a leading indicator before you start firing people. You’ll cut out all the overtime long show. So at any rate, the leading economic indicators peak before a recession, peak before a recession, they fall, big recession, it took forever to get back to where we were March of 2017. When they fully recover, on average, we grow them for another six years, almost 71 months, called six years. So March of 17 had six years to it, you get to subtract the month, February of 2014. Okay, February 25.

[22:25] Scott Colbert

Now, that has a lot of variability around, okay, this doesn’t, for every year that you have a steep yield curve, meaning that short term rates are higher than long term rates, you get 1.19 years of recovery. Look at that. It’s almost a perfect indicator. And we had a steep yield curve for 151 months. We’ll call it off because last August, the yield curve inverted the Fed was fairly slow to take rates away. It was July when they finally started to cut the race. We had an inversion in July. So we’ll call that short. And we have 151 months of a steep yield curve that would tell you that we would go out to till May of 23. So we’re getting about the same answer. This chart has a lot more consistency than the previous chart. But we’ll split the difference because I don’t want to get to exact, and we’ll just call it April of 23. We will pick the day. I’ve got one for April 14. Why? April 14. I’m sure you all know that. Pete Rose’s birthday. I’m from Cincinnati. So that’s the only people in Cincinnati care about that. I heard he was trying to get back in the home or back into baseball just a damn because I headline about that just a day ago. So anyhow, they’ll the whole idea is that it won’t be April 23 unless I get really lucky. But then it’s a lot further out there than people think that we would normally take to use up all of the stuff that we need to do what generates the friction that ends ultimately in a recession.

Now we’re getting helped along because interest rates are ungodly low too, right. So, you know this whole expansion and your foreign interest rates, in fact, the average borrowing rate at the end of the year for the average 10-year bond for the next six largest borrowers on the planet, and there they are Italy, the UK, Spain, France, Germany, Japan, is only 52 basis points. So basically foreign entities can borrow for almost free, in fact, that even Greek debt fell towards 1% in January, which is just unbelievable that people would give yield to buy a Greek bond. Why are they doing that? Why would that how could that be? It’s the European Central Bank, you can’t see all those numbers over there. But basically, the United States has chewed up 17% of the Treasury market. They just bought them. They quantitative release, they bought them in and what’s the neat thing about the Treasury Department or actually the Federal Reserve was the Treasury is fine. What’s the new thing about the Treasury that they can do this? How can they do this? They can print money. Unlike you and I have to have real money, they can just create the money and buy the bonds. And that’s what the European Central Bank, bought up 26% of the entire bond market. Japan has bought up half their bond market and the UK about 18%. So this quantitative easing has helped drive interest rates to an ungodly low level. Now, if you don’t believe me, though, that we still have till 23, I want you to think about what It normally takes to put this country into a recession. It takes two things. It takes number one, a Federal Reserve that is breaking the economy and pushing on the brake and slowing things down. And number two, it takes fancy $5 word with inflation used to be $3 word and exogenous shock of some kind. Now in our lifetime, we’ve had a number of shocks and pushes through the recession. In the 1970s it was the Arab oil embargo and energy prices. In 1980, it was the wage-price spiral and Paul Volcker stepping on that, in 1990 it was the first Iraq war, in 2000, was the internet bubble and in 2000 was 1000 classes, so you guys can pick your exogenous shot. Maybe it’s the coronavirus? I don’t think so. Maybe it’s the trade war. We said no, the numbers didn’t been the point of it possibly being big enough. It’s something but you also have to have a Fed that’s breaking. And on average, look at the last three recessions on average, that funds were either 3.3% above trailing inflation 4.1% above trailing inflation or two and three quarters, that averages to three and three-eighths over trailing inflation. In other words, the Fed has to break basically and put about 3% of a break versus trailing inflation on cash so that you say to heck with buying a bond, to heck with buying a stock, to heck with investing in plant capital equipment, to heck with hiring any more people, to heck with buying emerging market, whatever. I’m just good hold some cash. And where are they today?

[27:06] Scott Colbert

Today they are literally peaked at 50 basis points, and today they’re minus 15 basis points essentially having lower grades. So the Fed isn’t even breaking at all on the economy. Historically, what that chart told you was they might have to get rates up towards 5% to break as hard as they’ve had to in the past to push us into a recession. And that’s what everybody wants. Everybody wants Colvard when you get a 5%, five year Treasury, what can I get 5% my cash the answer is probably not in my lifetime, because I just told you, I’m at the tail end of the boomer generation, I’m 58 years older, the IRS says I’m supposed to live till I’m 83. That’s 58 minus 83, I got 25 years before you get back rates that are high until I die, and the boomers leave the planet, we probably aren’t going to get these rates really up.

Now, the other thing that’s helping us have ultra-low rates, of course, is that inflation is modest and it’s been coming down our entire lifetime. Inflation averaged 4.1% post the wage-price spiral and the call that built-in recovered, it averaged 2.1% during the Clinton recovery and this inflation rate is the rate that the Federal Reserve uses the PCE personal consumption expenditure, core inflation rate has a mouthful, but core PCE 1.2 point one during the current recovery during the all will call that the George Bush recovery 1.9% inflation and during the combined Obama and Trump expansion, inflation has averaged 1.6%. So the Fed can’t even get inflation up to its target. It continues to come down why it’s been coming down. Basically secular forces the Fed has a hard time fighting. All the debt has slowed things down, right. And in fact, the multiplier to more debt might be even negative, right? Instead of borrowing and adding, you know, your economy, you’re to the point where if you buy more, you don’t help it at all. The demographics, of course, that we talked about are slowing things down. And then I think it’s technology, right, it’s access to unlimited labor overseas, because of Amazon and the cargo container ship and Ali Baba and technology that gets us unlimited access to that cheap labor, basically, for the rest of our lives, that continues to hold inflation at bay. And so this is why we don’t expect the Fed to, you know, basically raise rates at all because they can’t even get inflation up to their target and an accommodative fed you have a hard time having a recession with an accommodative Fed. Now, the Fed did begin to cut rates back in what, July of 2019. Because the Fed seemed that things were slowing, their rates were too high, the yield curve inverted a little bit, and the yield curve is 9 for 9 at coin or recession.

And so the Fed didn’t want to ignore the yield curve. They want to get it back to a steeper yield curve. Basically two things happen after you either cut rates either have a recession, or you don’t, okay, either have a hard landing or you don’t if you don’t have a hard landing, and that was our call that you wouldn’t have a hard landing, stocks on average are up one year later post a Fed rate cut, almost it’s hard to believe 30% here’s where stocks are today. So meandering along the blue. This is why stock traders get paid so much more than us bond managers because it was a 50-50 toss-up which way this thing was going to go. Ah, what about interest rates? What happens when the Fed starts to cut interest rates where our 10-year interest rates one year later? The American economy recovered doesn’t matter whether it’s not recovered interest rates are lowered dummy because the Fed cut interest rates. So as bond managers, being dumb people, have added maturity and added duration and right here’s where the 10 year Treasury is now, into this recovery tracking along the path. But basically this is telling you that this is basically a software and that we’re working through. And it didn’t matter as a hard or soft landing rates aren’t likely to rise anytime soon, at least materially and of course, they fallen stocks are up, 9.4% says they recovered and then shrink stranger down 20 basis points, you know since the Fed cut rates and we’ve had the 10-year drip five, you know, five times we’ve had the 10 year treasury get below 2%. It dipped below on eight 119 I’m just going to take quite a while for the 10 year Treasury to get back above. Now, this is my one chart on the coronavirus. Now first off, there are 24,000 cases that seem scary. There are 500 deaths, mostly in China. 99% of these cases are all in China. China has four times the number of people that we do but in this country, how many people die every day?

[32:01] Scott Colbert:

Almost 1000-7500 people die every day. Now we’ve got 450 deaths total. So it’s about you know, it’s been 10 or 15 deaths a day, that’s 7500 people die in this country every day, as one every 12 seconds. Could you all make it in this presentation, I’m going to check you and she says we’ve all made it. So you know, on a relative basis, this is just a very in China, there are four times that number, just for example, guys, right people, there are nearly 30 million people a day that dies, not 30 million people, 30,000 people a day that died in China. And you can see that this is just a speck, there are almost 150,000 people globally that die every day. And so it’s just not the kind of thing that has an effect. It has an economic rounding error. Now, that doesn’t mean it’s not impacting some supply chain. It doesn’t mean that it won’t impact China where 90% of the cases are, but it’s gonna have a very marginal effect here in the long run. This is we’ve had six of these pandemics before SARS, the blue flu, swine flu. I don’t even know what the hell this is the wild polar virus, I don’t know ebola as a baby in the Zika.

Now, this is on average what the stock market does 12 months prior to the risk these to these breakouts. And then here’s what the stock market does after and the day here is the day that the World Health Organization declares a global emergency. When did the World Health Organization declare a global emergency? What is it last Friday? And what is our stock market done? It’s fallen 3.1% into it. And as of this afternoon, it was up exactly 3.1%. Post the crisis. So this is tracking almost perfectly and I expect that we will really work through this without much to do in the long run. And it just shows you about psychology because remember we had just assassinated this Iranian general that was going to bring us to the to our knees and if I asked you how many people remember what the name of the general was? Remember, this was gonna be the big crisis, a crisis. And almost no one can remember what even happened. All right, and this tool will be forgotten shortly. The nice thing about these things, not that there’s much nice about a coronavirus, because it’s scary and you can never just watch those up there. There’s a pandemic movie.

But these little pauses that we get along the way of this recovery, create a situation. I call them the pauses that refresh. They keep things from getting a little too overheated. So the Fed doesn’t have to squash us. We’ve gone through four of them now maybe even five, think about we had the political debt crisis. And we used to say, even if Greece collapsed, the GDP of Greece was out of Indianapolis. And when Peyton Manning left Indianapolis, Indianapolis, worked through it just fine. They’ve lost quarterbacks here in Dallas and they made it through those two right they lost 8 million. We had a Brexit job. I didn’t have much to do last year, we had the energy crisis from that and 16 that’s sweet this California and now we’ve got the coronavirus and the trade war that we’re going to basically clauses that are allowing this economy to continue. Now, we all know that you made a lot of money in stocks last year, made less money in emerging markets and international stocks. There are international emerging market stocks 30% here 20% overseas, and even my lowly bond fund had a 9% return on it last year. Remember CFB annex and go, guys, all have you? Have you been sending money in from your checking accounts? I’m sure there’s a way you can wire it in. I don’t know how you do it, but I’m sure you can figure it out. So this was returns last year, and of course, they were fantastic. But when you think about it, this is the 378% bull market that we’ve had in stock so far, the biggest bull market we’ve ever had without this proverbial 20% correction was during the Clinton internet bubble if you will when stocks were up 400%, 380%, 400% during the internet thing, that internet that, you know, the end of that recession, stocks fell 50%. So we’ve had a quite, quite a run, whoops, this one.

[36:18] Scott Colbert:

And stocks, you know, are not cheap. They are, you know, they’re average to above average based upon forwarding P ratios, but they’re certainly not cheap. And when we look at basically every valuation metric that we can find forward PE, Schiller’s PE which is based upon trailing earnings, the dividend yield prices to book prices cash well, stocks are from a half a standard deviation to 1.2 standard deviations, 1.3 standard deviations rich to where they have a better score. The only thing that makes them seem cheap is this last year. And it’s the interest rates are so gosh darn low, when you compare it to basically a basket of corporate bonds, you could buy a basket of corporate bonds, and the yield on that right now is only if you bought up all the triple B credits in the country 10-year average maturity, the yield on that is only 1.5% more than the earnings yield basically, of the S&P 500, which makes them cheap. And another way of simply saying that is because interest rates are so gosh darn low, it makes that 2% dividend yield in that P of 18 looks a heck of a lot better. And that’s why your companies are buying back all this stock because they really don’t have much else to do with the money if there isn’t something to do in the business. Now, the reason that this all matters and the economy matters is because ultimately, the value of all of our goods and services is tied back to it in some way. And the value of the stock market is tied back to it in some way.

On average, the S&P 500 is worth about 1.1 times the size of the economy. And right now it’s valued at about 1.2 five times the size. And the valuable your housing is about 1.1 times the size of the economy. And the value of housing is about 1.4-1.5 times. But let’s look back at some historic bubbles that we know. In 2000, we knew we had an internet bubble. And when you look down, you basically see that houses were 1.8 times GDP are not houses, but stocks were 1.8 times GDP stretched. And if you look in 2007, we know that the exact opposite happened, housing was stretched at about 1.8 times GDP and equities were about flat. So you get this, this kind of anchored about 2.9 times GDP, and it’s tough to break through that or a ceiling. It’s been tougher, either or the combination of the value of our houses and a combination of the value of our stocks, which is where most of our wealth is to break through this 2.9 times GDP. Now here’s where it peaked again, last December to about 2.9.

There is a six month lag on this chart of pixels. I want to put the data together. But I think when I get the new data at the end of the year, we’ve broken through it. And the reason that we’ve broken through it is that we’ve suggested that we are going to go to overtime, this time is different. That’s a dangerous thing to say. But essentially, because interest rates are so low, the difference between this, this and this is we had a 5% tenure, a 5% tenure, and a 1.65% tenure. We know that housing is a levered commodity, right. And the lower those interest rates go, the more you’re willing to pay for a house. It’s the same way with stock and both stocks and bonds have been appreciating, but neither is as a grievously valued stock at 1718 or houses at 1718. Neither is where they’ve been historically high. But I think with this low-interest-rate environment in the fact that we’re going to go to overtime in terms of the economic expansion will end up pushing on these both and will end up here somewhere since the football season just ended as though we just wanted to overtime and played in overtime and will still end up here will wind up off the chart. Okay, maybe I’m right. But what if I’m not? Because this is what happened. The last two times we had a recession. S&P 550%, S&P 500 fell 55%. Next recession S&P 500…

[40:26] Scott Colbert:

As we know that stocks aren’t cheap, right? And about the only way you can protect yourself against this isn’t to buy gold. Gold works sometimes, sometimes it doesn’t actually fall off in times of recession. You can’t buy cash because cash flow is a negative one you’ll get purchasing power and it’ll hold the value but you won’t you won’t make any money. The banks will have your cash at negative rates this next recession. It’s to buy long duration high-quality bonds. The people that are the most unloved panel on the planet is the 30-year treasury bonds at 2.3% but it was unloved at three, it was unloved at four, it was unloved at five, you’re going to love it if it’s at one when you bought it at two, three. But if you think about it the trend in rates here in this country, what happened in Japan eventually happened to Europe. What’s happening in Europe is slowly happening here, because of the debt, the deficit in demographics was like fighting. Basically, you’re fighting, fighting a trend here.

And I think that you know, the only thing you can really do to help protect yourself is to add a few bonds. While the times are good. It’s very difficult to sell that S&P 500 spider when it’s making you all this mind, I know that but think about what you just went through in January, they’re finally after a 33% month, the virus, the scare, and all that stuff. If you had to rebalance or think about it, the only way to protect yourself and it’s not to buy short term securities. It’s to buy longer-dated securities as my one plug my eyes are going to ask for you thinking about only a few bonds. None of you will guarantee you, we will all walk out here, but at some point, and we think it’s in the future yet if you really want to respond because we think we’ve got more time to go, but nonetheless, it’s coming and the recession comes, your 401k gets turned into 201k again. And if you’re like me if you’ve already done this twice, we don’t want to do it when you’re 65 you really just don’t. So I’m forced to be a little more conservative than I used to. So that’s my story at the bank. The economic expansion lasted longer than you think stocks probably going into overtime. But nonetheless, eventually this this this funny games and when it does it, it ends with pretty good laughing usually. And if you’re paying attention to your own life, it’s going to whack it pretty hard. What questions might you have and then you can move in half. What’s happening? Yes, sir.

[42:59] Audience:

Sorry. A couple of questions, lack of personal savings and also rising health care costs that really aren’t being addressed by any of our government?

[43:07] Scott Colbert:

Yeah, well, you know, the lack of personal savings is largely what’s driving this slowdown. Because if you haven’t built up enough savings as you age, what are you doing? You’re starting to buy less and less. And you’re trying to save more and more. Now the savings rate actually has rebounded materially since the last recession when savings rates were actually negative. And it actually has grown fairly positive, because the markets are doing well. People are actually incentivized to say, and you got this agent demographic, so the savings rate is rising. But that’s also as the savings rate rises, which also slows enough economic growth. Now, in terms of health care costs, that is the driver of the deficit, right? We’ve seen an inversion here in our lifetime, where basically, energy used to be 14% of GDP, and now it’s less than five and healthcare used to be less than five and now it’s 14 plus percent GDP. So we’ve watched oil we traded oil for healthcare. And this can’t continue to last. I always, Ben Stein, I know Ben Stein from Ferris Bueller’s Day Off, his dad was Herbert Stein, a Nobel winning economist. And his favorite saying was I’m paraphrasing, “What can’t happen won’t”. And we can’t spend 25% of GDP on health care. We just, we just won’t break us. And so what happens when you don’t have the money to spend, you push back on it, and what we’ve got coming in healthcare because the eventual Walmartization and immunization of healthcare, healthcare is so fragmented. And it’s consolidating, the largest hospital system in the country only has $45 billion in revenues. It’s a modest, you know, deal, and it’s the biggest. So we can see that there’s still, you know, consolidation coming in that private healthcare space because if you’re in a hospital with a billion dollars in revenue, you’re going to get eaten up. It’s like the banking business where you know, there are four banks that control half the market Wells and JP Morgan and Citigroup and Chips. Right. So that’s half the market for the 14th largest bank. We don’t care where the branch office of Bank of America, they say, who tells that Google on that branch office out there in Missouri? Anyhow, let’s fire that guy. Look, what a new person and that will fail, you know, they won’t even know exist. So that’s what’s going to have to happen with healthcare to get the economist economization going in that space. Yes, sir.

[45:31] Audience:

Yes. And when you’re if you have any insight from the 2017 tax plan, or whatever they call that thing, that tax reform, that it was built on the idea that we would have, like three and a half percent, I think was the growth expected over like a 10 year period or some timeframe. Otherwise, we wouldn’t make enough more enough revenue to compensate for the additional cotton Dasa revenue for the government. How are we tracking?

Scott Colbert:


[46:04] Audience:

So just like there’s an overhanging that respect coming up?

[46:07] Scott Colbert:

The overhang is that our deficit is increasing faster than we would expect because the cutting taxes didn’t boost growth as much as the Trump administration has held. Now, it has certainly boosted growth a little bit. We did have 3.1% growth, which was the peak in the growth cycle, but tax revenues didn’t even come close to catching up and our deficits actually went from about 4% of GDP to five, we can run, it’s a dirty little secret is we can run 4% budget deficits the rest of our life, and never grow our debt ratio, because nominal growth is four-point plus percent year. It’s almost 4.3% last year. So in other words, if you’re making 100,000 and you’re borrowing 100,000, and you promise me we’ll make 104,000 next year, you can borrow 104,000, you can run a 4% deficit. And that’s what our country typically has done. We’re one time GDP but I don’t doubt that the deficit is going to accelerate, which by and so, you know, that will, in the long run, probably push back on growth eventually, it’s a near term stimulant. For a long term headache we have to deal with, when will we run out of rope? In other words, when will the world stop lending us money at one, one and a half percent? The finances deficit? And the answer is historically, usually, when a country gets about two times debt to GDP ratio, and its government debt, that’s when people start to back away. That’s still a long way away. And we’ve got a lot of rope that the world would give us as the only superpower and 20% of the world’s economy. They’re going to give us a lot of rope. And Congress will take that rope, and they will eventually hang us until it starts to tighten and hurt us. They aren’t going to do anything about it. Because they just don’t, Congress, you know, do anything. Unless there’s an emergency. I think they know that. There’s no emergency right now. So we’re not doing that right now.

[48:03] Audience:

So I want to take your advice and figure out, you know, what portion of my portfolio should be bonded? Yeah. When I look back at if I if it had been 2007, and I had tried to allocate some portion to bonds, you know, maybe in the short term, it would have looked smart. But now seeing the last 10 years of growth, so what’s going to happen after the recession, so that April 2023, right, so for those of us who are a little bit, have more risk-tolerance or have more time, what do you suggest?

Scott Colbert:

Sure. And you know why this is why I’ve largely stuck with the stocks my whole life, you know, through this thing, because the relative value in the bonds versus the long term value in stocks, and I still would say, this is very true. That you know, you still want to maintain as much equity as you can. It takes about three and a half years after the crisis for a 60-40 balanced portfolio 60% stocks, 40% bonds to fully recover, it took damn near the whole seven years to get back to the internet bubble before we had a crisis again, and you were back there again. And so you can see when it’s an equity-only portfolio, it can take you a heck of a lot longer to recover. And I might add, we’re lucky because when a country that allocates capital with a gun put to our head, and what I mean that is, is that basically get the pizza joint down the street isn’t good pizza joint, it goes out of business, as do most companies in this country, unlike in Europe, where they get held a lifeline and in Japan, and even in China, to a big extent. So we reallocate capital quickly.

That’s why I think our stock market can avoid what happened in Japan, and the stock market peaked in 1989. It’s still only 40% of our European stocks peak back in 2007. They’re only at 60% adapted, there’s no guarantee that we have to keep going up. And we’ve been boosted by interest rates of course, over my lifetime and I’m 18 and 1979. I graduated till today, I watched interest rates go from 21% in cash to zero. I wrote the back of the biggest bull market equities that helped propel the long by that lowering interest rates, those interest rates are no longer now going to help me anymore. So you’re not looking at the same returns going forward? I only tell- you have to be a little more cautious. But I also say as long as you got time, don’t worry about I have less time. So I gotta worry a little bit about, I can’t afford to lose half my money. I can’t afford to. You can because you’ll make it back up. One last question. Come on, ask me about the election. Iowa caucuses something. We appreciate getting to speak to you. Thank you for having us down here. And I will tell you, I am truly excited to be in Dallas Cowboy stadium. I really did. I grew up liking the Cowboys, like a lot of people my age. So it’s really, really fun to be here.

[0:00] Scott Colbert The crowd can only take away so many things. And so I’m going to give you four things to take away. All right. What’s the first one we’re going to take away? What’s the first thing everyone’s talking about when you wake up other than Tesla? [0:15] Scott Colbert Coronavirus, right. All right. Don’t worry about it. All right. [0:23] Scott Colbert Second thing, it will have a modest impact, but we expect global growth to accelerate and US growth to accelerate. That is an out of the consensus forecast now because everybody says the coronavirus is going to kill us. Okay. All right. That’s, that’s the second thing. The third thing is we expect this economic recovery, which is now 10 and a half years old and the longest economic recovery we’ve ever had in the country to continue to last, a while longer, and a lot longer than the average forecast is. And then the fourth thing we’re going to finish with is stocks. You all have too many stocks probably in your 401k, they’ve gone to the moon. We’ll talk about how expensive they are and what you can do to maybe range some…

What you'll learn

Negative rates are a reality in several developed markets across the world but is it possible in the US? Join Scott Colbert, Chief economist of The Commerce Trust company as he speaks on the forces which have driven US rates to historical lows, their nature (cyclic vs secular) and the positive or negative implications they have on member companies.

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